Refinancing a Personal Loan

Refinancing a loan is a replacement strategy. You replace one loan with another one, presumably with far better terms or in an effort to save you money. We typically think of refinancing car or home loans, but any type of loan can be potentially refinanced, including personal loans.

To refinance a personal loan, all you will essentially be doing is taking out a new loan to pay off the balance of the first loan. You apply for the new loan, and once it is approved and funds have been released to you, you use those funds to pay off the full remaining balance of the first loan. Then you start making your, hopefully lower, payments on the new loan.

Why Refinance a Personal Loan?

There are many reasons why refinancing a personal loan makes sense.

Your credit has improved. If your credit has improved significantly, you may qualify for a better
interest rate on a new loan. That lower APR will lower the payment and you’ll wind up paying
less for the loan over time.
Interest rates have dropped. If you took out a personal loan in a time when interest rates were
high, even if your own credit hasn’t improved, you may be qualified for a lower payment now
that interest rates have lowered across the board.
Your income has decreased. If you are making less money every month, you may be able to
reduce your personal loan payment substantially by refinancing the remaining balance of your
loan for a longer period of time. This would hopefully give you breathing room in your monthly
budget and still allow you to make timely payments.
You have a balloon payment due. If your loan started with low payments and ends with a giant
amount due in a single payment, refinancing the loan may be the only way you’re able to pay off
that large balloon payment.

How to Refinance a Personal Loan

Refinancing a personal loan will essentially follow the same steps as taking out your loan the first time.

You will want to:

Calculate your needs. If you are looking to pay off one loan with another, figure out exactly how much it will cost to pay off the first loan. If you are getting a bit of extra cash for a new need, include that figure in the calculations.
Shop rates. Find the best rates available by speaking to your current lender, your other financial institutions, and looking at rate comparison tools online.
Look for hidden fees. The more fees you pay, the more you’ll be paying for the loan – even if it comes with a much lower APR. Always calculate fees into your repayment plan.
Apply for the best loan. Follow the application process for the new loan. At this point, the bank or lender will check your credit and hopefully issue you the loan you’ve requested.
Pay off the first loan. Use the proceeds of the loan to immediately pay off the old personal loan. Your new payments will start almost immediately, and you don’t want to wind up being stuck with two personal loan payments.
Confirm the original loan is closed. Watch the original loan to be sure the payment was applied correctly and that the original loan is showing up as paid in full.
Start payments on your new loan. You may be able to enjoy a short reprieve on payments based on the new due date for the new loan but be sure you start making payments on your new loan immediately.

Considerations for Refinancing a Personal Loan

Refinancing a personal loan doesn’t always make sense. There are a few potential downsides that might appear if you plan to refinance. As you are investigating your options be mindful of the following:

Prepayment penalties. If you original loan has an extra fee for paying off the balance early, you may wind up losing money by refinancing.
Extended payments. If you refinance a personal loan and extend payments, you will almost certainly pay less every month – which may be good during a period of under or unemployment – but you will possibly pay far more over time. The APR will be applied to that loan over its new duration, making you pay quite a bit more if you extend the loan for years past its original due date.
Extra fees. New loans often come with new fees. If you take out a new loan, you may wind up losing any potential savings with a new fee you’re charged. If you find that to be the case, it may not make sense to refinance.
Credit score impacts. Applying for a new loan will create a negative impact on your credit score. The inquiries as you shopped a loan can harm your credit score, albeit temporarily, and a new, larger loan can also bring your score down.

For many families trying to find the best means of budgeting their income, personal loans make a lot of sense. But sometimes an old personal loan can create more trouble than benefit. If that’s the case, it makes a lot of sense to consider refinancing that personal loan. You’ll likely pay less over time and benefit from a far more favorable APR with a smart personal loan refinance.