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Should You Refinance a Personal Loan? | Personal Loans and Advice
Personal loan refinancing is when you take out a new personal loan to repay the balance of an existing personal loan on better terms. It’s possible to refinance a personal loan to save money on interest, lower your monthly payment or pay off debt faster.
That being said, personal loan refinancing isn’t a good idea in every circumstance. You should run the numbers to determine if refinancing is the right move for your financial situation. Keep reading to learn when you should (or shouldn’t) refinance a personal loan, as well as how the personal loan refinancing process works.
Generally, personal loan refinancing is worthwhile if you can save money on interest over the life of the loan. This effectively reduces the cost of borrowing, can help you get out of debt faster and even reduce your monthly payments in some circumstances. Here are some cases in which personal loan refinancing can be a good financial move:
You can qualify for a lower interest rate than you’re currently paying. When refinancing any type of loan – such as a mortgage, student loan or personal loan – you should typically only move forward if you can qualify for a lower interest rate than you’re currently paying. The only exception is if you refinance to a much shorter loan term with overall savings that offsets a minimal increase in your interest rate.
Your long-term interest savings makes refinancing worthwhile. This is especially important to consider if your original personal loan has a prepayment penalty for paying off your loan early, or if your new personal loan comes with a loan origination fee.
You can reduce your monthly payments without adding to the overall interest paid. It’s possible to save money on your monthly payments without adding to the total cost of the loan if you can lock in a lower interest rate and keep your repayment term about the same.
Here’s an example of how you could save more than $1,000 in interest over time and slightly reduce your monthly payments by refinancing to a lower interest rate while keeping the same payoff date:
| Old personal loan | Refinanced personal loan | |
| Interest rate | 17% | 12% |
| Original loan amount | $15,000 | $12,140 |
| Remaining loan amount | $12,140 | — |
| Original repayment term | 48 months | 36 months |
| Remaining repayment term | 36 months | — |
| Monthly payments | $433 | $403 |
| Interest cost on remaining balance | $3,442 | $2,376 |
| Potential interest savings | — | $1,066 |
You can pay off your debt faster on a shorter loan term. Shorter-term loans typically come with lower interest rates, but you may have higher monthly payments if you choose a much shorter repayment term. In general, paying off your personal loan faster will help you save money on interest in the long run.
You can remove a co-signer without impacting the cost of repayment. If your goal is to remove a personal loan co-signer, refinancing can help. You’ll have to ensure that you have a sufficient credit history to qualify for a new personal loan with better terms without the help of a creditworthy co-signer.
Personal loan refinancing may not be a good idea if it results in higher overall interest charges. This means you’re paying more money to the lender at an increased cost of borrowing. Even if you can score a lower interest rate and monthly payment, your potential savings could be offset if you refinance to a longer-term personal loan. Here are a few circumstances in which personal loan refinancing may not be the right debt repayment strategy:
You can’t qualify for a lower interest rate than you’re currently paying. The higher your personal loan rate, the more money you pay to the lender over time. The only exception is if you’re able to meaningfully reduce your debt repayment period enough to cut down on your overall interest paid.
You’re prolonging your debt repayment period. While refinancing to a longer-term loan may help you save money on your monthly payments, it will result in higher overall interest charges and leave you indebted for a longer period of time. You could end up paying hundreds (or thousands) of dollars more over time if you push back your loan payoff date.
Here’s an example of how you may be able to reduce your monthly payments by $100 by extending your repayment term by a year, and how you end up paying nearly $1,000 in additional interest charges over time even at a slightly lower interest rate:
| Old personal loan | Refinanced personal loan | |
| Interest rate | 19% | 17% |
| Original loan amount | $20,000 | $14,154 |
| Remaining loan balance | $14,154 | — |
| Original repayment term | 60 months | 48 months |
| Remaining repayment term | 36 months | — |
| Monthly payments | $519 | $408 |
| Interest cost on remaining balance | $4,524 | $5,450 |
| Interest added | $926 |
You’ll be charged an origination fee or repayment penalty that offsets your savings. Check to see if your original personal loan lender charges a prepayment penalty for paying off the loan early. And if your new personal loan lender charges a loan origination fee, be sure that this cost doesn’t outweigh the potential interest savings.
You can’t afford your new monthly payments. Switching to a shorter-term loan on a more aggressive repayment term can be an effective strategy to get out of debt faster and save money over time. But if you can’t afford the higher monthly payments of a shorter loan term, then you could end up incurring late payment fees and hurting your credit score.
In most cases, the eligibility criteria for refinancing a personal loan are the same as for borrowing an original personal loan. Lenders will look at your credit score and debt-to-income ratio to determine if you’re a good candidate for personal loan refinancing. You’ll generally need a credit score of at least 600 in order to qualify, but the most favorable loan offers will be reserved for those with credit scores in the mid-700s or higher.
If your credit score has improved since you originally borrowed the personal loan, then you may be able to lock in a lower interest rate by refinancing. But if you have fair or bad credit, then refinancing may not be worthwhile.
Personal loan interest rates decreased slightly this week for the 36-month term and increased for the 60-month loan term. Here are the average personal loan rates offered to well-qualified applicants with a credit score of 720 or greater, as of June 5th:
- Three-year personal loan term: 19.64% (down from 19.78% a week ago).
- Five-year personal loan term: 20.42% (up from 20.23% a week ago).
Personal loan rates vary widely based on creditworthiness. Borrowers with very good or excellent credit scores will see much lower interest rates than those with fair or poor credit. Often, borrowers with bad credit will apply for a secured personal loan that uses an asset as collateral in order to achieve lower rates:
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- Check your credit score. Since your credit score will determine your personal loan eligibility and interest rate, it’s important to know where you stand before applying. Many banking apps let you check your credit score for free without a negative impact. You can also request a free copy of your credit report from all three credit bureaus – Equifax, Experian and TransUnion – through AnnualCreditReport.com.
- Read the loan agreement for your existing personal loan. This will help you determine how much you need to borrow, how many months are left in your repayment term and your current interest rate. You should also examine your documents closely to see if your current lender charges a prepayment penalty.
- Prequalify through a few personal loan lenders. Most (but not all) lenders let you prequalify to check your estimated loan terms and eligibility with a soft credit check, which won’t impact your credit score. This lets you shop around for the lowest possible interest rate for your financial situation before you formally apply.
- Choose a loan offer that works for you. Using the criteria in the sections above, determine which loan offer is best for you. When comparing loan offers, look at the annual percentage rate, or APR, which includes the interest rate as well as any other fees. You should also weigh the overall interest charges, monthly payment and debt payoff date.
- Fill out a formal personal loan refinancing application. Once you’ve decided on a loan offer, you’ll fill out a formal application. At this point, the lender will take a closer look into your financial history. Applying will trigger a hard credit inquiry, which will have a negative but minimal impact on your credit score. Upon approval, the lender will disburse the funds to you, which you must use to pay off your old personal loan, or pay your previous lender directly.
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Make extra principal payments. Refinancing isn’t the only way to repay personal loan debt. If you’ve determined that personal loan refinancing won’t benefit you financially, then you could consider making extra principal payments on your loan to pay off the loan faster. This won’t reduce your monthly payments, but it will save you money in interest charges in the long run. But first, see if your lender charges a prepayment penalty for paying off your loan early.
Take out a home equity loan. You could look into secured loans to pay off your personal loan debt on better terms. For example, a home equity loan will typically come at a lower interest rate than an unsecured personal loan, which can save you money over time. It may also allow you to extend your repayment period without adding to the overall interest cost. However, you should be sure to account for any closing costs and fees associated with borrowing a home equity loan. And remember that since your home is used as collateral, you risk losing the roof over your head if you don’t repay the loan.
Ask for help. If you’re considering refinancing your personal loan because you simply can’t afford it, you might consider working with a certified credit counselor to create a debt management plan. Nonprofit credit counseling agencies can help consumers who are struggling to repay their debt, often at a low cost. A credit counselor may even be able to work with your creditors to negotiate lower monthly payments, reduce your interest rate or waive fees and penalties.
