Finance

How to Refinance a Personal Loan and When to Do It

When you took out that personal loan to complete a home renovation, consolidate debt, or pay for unexpected expenses, you breathed a sigh of relief. Since then, however, your monthly payments have you gnashing your teeth in frustration. Knowing how to refinance a personal loan can save you money, and it may even help you pay off your loan faster.

What Does It Mean to Refinance a Personal Loan?

Refinancing involves replacing one loan with another. When you refinance a personal loan, your new lender will pay the remainder of the original loan and set up a new loan that you’ll start paying.

Many borrowers pursue refinancing to secure a lower interest rate. When the interest rate is lower, you’ll save money during the overall life of the loan.

How to Refinance a Personal Loan

You can obtain a refinancing loan by following these basic steps.

  1. Evaluate Your Current Loan – First, check your current loan balance and interest rate to decide whether refinancing is right for you. If your loan balance or interest rate is relatively low, you may choose to keep your current loan rather than refinance.
  2. Check Your Credit Score – There are many ways to get a free credit score. If your credit score has improved since your original loan, there’s a good chance you’ll qualify for better refinancing terms.
  3. Compare Lenders – Shop around. It’s always wise to compare rates from at least three different lenders. Ask questions before you apply, making sure you understand any additional origination fees or other costs that can impact the overall cost of your new loan.
  4. Apply for the Loan – Once you find a lender you like, complete the application process. Every lender is different, but most will ask for the following information:
    • Social Security number
    • Driver’s license or government ID number
    • Existing loan paperwork
    • Employment documentation (W-2, pay stubs, etc.)

☝️ Your lender will also do a hard pull of your credit history. A hard pull will temporarily lower your credit score, so use caution if you plan to apply for other forms of financing in the near future. But this drop should be minimal, and as long as you keep up with your payments, your credit score should recover quickly.

  1. Keep Up with Your Payments – There may be a delay between the last payment of your original loan and the first payment of your refinanced loan. Make sure to keep up with both loans until you’re sure the transition has taken place. Otherwise, you may face late fees, damage to your credit, and other penalties.

🏆 Here are the best personal loans for excellent, good, fair, and bad credit, plus information about what to expect and how to prepare.

Pros and Cons of Refinancing a Personal Loan

Before you commit to a personal loan refinance, you should consider the advantages and disadvantages of refinancing.

Advantages of Refinancing a Personal Loan

Depending on the terms, some pros of refinancing a personal loan might include:

  • Lower interest rate 
  • Shorter repayment period
  • Lower monthly payments (sometimes with a longer repayment period)
  • Fixed interest rate

These advantages can help you repay your loan faster, make lower monthly payments, or both.

Disadvantages of Refinancing a Personal Loan

Along with the benefits, there are some potential disadvantages of refinancing your personal loan. For example, suppose that you refinance to a longer loan term to lower your monthly payment. In that case, you will likely pay more interest overall.

Other potential disadvantages include:

  • Loan origination fees
  • Potential for denial due to low credit score
  • Short-term negative impact on your credit score
  • Possible prepayment penalties

Some of these drawbacks vary among different lenders. Some lenders require higher credit scores than others, and fees can likewise vary between financial institutions.

When Is the Best Time to Refinance a Personal Loan?

Refinancing has a simple goal: to save money, whether in the short term or long term. But certain circumstances can help you maximize your savings. Here are the best times to refinance your personal loan:

  • Your Credit Score Has Improved – Interest rates are largely governed by your credit score. If your credit score has improved since you first obtained your personal loan, it’s likely that you can now qualify for better rates. Typically, borrowers with a credit score above 690 and a low debt-to-income ratio have access to the most favorable rates.
  • You Need Lower Monthly Payments – Have you recently purchased a car or a home? If so, your monthly budget may look completely different than when you applied for the original loan. Likewise, if you change jobs, you may discover that you have less monthly income than before.
    Refinancing your personal loan to one with a lower interest rate can lower your monthly payments. But you can also lower your payments by extending your loan term and distributing smaller payments over the course of your loan.
  • You Want to Pay Off Your Loan Faster – Many borrowers refinance in order to shorten their loan term. While this can raise your monthly payments in the short term, it lets you get out of your debt more quickly.
    Paying off your loan more quickly can be particularly helpful in lowering your debt-to-income ratio, which may impact your eligibility for other loans, such as a mortgage. Also, you’ll likely pay less money over the life of your loan since you’ll be paying less toward interest.
  • You Want to Switch Your Rate Type – Some personal loans come with a variable APR. This can mean low monthly payments when rates swing low, but it can also make it difficult to plan your budget from month to month. Refinancing your personal loan can help you secure a fixed rate, which gives you more control over your monthly budget.
  • You Want to Avoid a Balloon Payment – It’s not uncommon for personal loans to come with a balloon payment, which means that the loan term ends with a massive final payment. It may be possible to refinance this type of loan to avoid the final balloon payment. Essentially you are borrowing to pay off the balloon payment and then paying off the new loan.

When to Avoid Refinancing

Sometimes, it makes sense to continue with your original loan rather than pursue refinancing. Here are some of the most common reasons not to refinance:

  • You’re Reaching the End of Your Loan – The less money you owe on your current loan, the less it makes sense to pursue refinancing. After all, you’re unlikely to secure loan terms that offset the origination fees your lender charges. If your current loan balance is relatively small (say, less than 20% of the original loan), it’s best to continue paying your current loan.
  • You Face a Prepayment Penalty – Many lenders assess a penalty if you pay your loan off ahead of schedule. When you refinance, you’ll still be responsible for this penalty. In some cases, your new loan terms will offset this cost, but you’ll need to make sure that the added prepayment and origination costs don’t make refinancing a poor choice.
  • Your Credit Score Hasn’t Improved – Lower interest rates are reserved for those with a credit score of 690 or above, depending on your lender. If your credit score hasn’t improved since you received your original loan, you’re better off keeping your current loan. You’ll actually improve your score by making consistent, on-time payments.

Learning how to refinance a personal loan will help you better manage your budget. The money you save can be allocated to your next major purchase, a much-needed vacation, or even long-term goals such as retirement.


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