When and how to refinance a personal loan

Woman learning how to refinance a personal loanImage: Woman learning how to refinance a personal loan

In a Nutshell

If you’ve borrowed money at a high interest rate, you may want to consider refinancing your personal loan to get a lower interest rate or reduce the number of monthly payments, especially if your financial situation has recently changed for the better. But in some cases what may look like a better deal at first can cost more in the long run.
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Refinancing your personal loan, in the right situation, can be a great way to pay off your debt and save money.

Saving money by refinancing high-interest debt into lower-interest debt is often one of the main reasons people get personal loans in the first place. But if you’d like to get a lower interest rate for an existing debt, it may make sense to refinance your personal loan.

In the third quarter of 2023, the average debt per borrower for unsecured loans was $11,692, according to TransUnion’s Industry Insights Report. In some situations, which we’ll explore below, refinancing a personal loan might make sense for you.

What is personal loan refinancing?

When you refinance a personal loan, you replace your existing loan with a new one. You may be able to refinance with the same bank or lender as the original loan — if it offers refinancing — or with a brand-new lender. If you’re approved for a personal loan refinance, the lender will provide you with a new loan with new terms that you can use to pay off your previous loan. There can be advantages and disadvantages to this, and in some cases you may see a negative effect on your credit scores.

Is refinancing a loan a good idea?

Here are a few cases in which refinancing a personal loan offers several potential advantages.

  • Possibly getting a lower interest rate — Refinancing your loan may provide you with the opportunity to get a more favorable interest rate than what you’re paying on your current loan. This is especially applicable if your credit has improved since you first took out your personal loan, in which case you may be able to qualify for a better rate on a new loan. Or, if interest rates have dropped, a lower interest rate could save you money on the overall cost of the loan, depending on what’s available based on your credit scores.
  • Spending less on monthly payments — Refinancing can also decrease the dollar amount of your monthly payments by stretching out the length of the loan. For example, if you’re struggling to make payments with a loan term of 36 months, refinancing into 48 months could reduce your monthly payment by increasing the number of months you have to pay off the loan. Keep in mind that extending the term of the loan like this can also mean paying more interest in the long run.
  • Reducing the number of payments — On the other hand, if your financial situation has changed, switching from a longer repayment period (like 36 months) to a shorter repayment period (like 24 months) means that you’ll be able to pay off your loan much faster, getting out of debt sooner, which can reduce the amount of interest that could accrue.  The loan calculator linked above can help you get a better picture of this as well.

5 lenders to consider for personal loan refinancing

  • SoFi SoFi offers unique member perks, including an unemployment protection program, career counseling, financial planning services, rate discounts and access to exclusive events.  
  • Payoff by Happy Money Payoff offers a personal loan geared specifically toward people who want to consolidate credit card debt. The lender can show you multiple payoff strategies to pick what’s best for you. You can also track your progress toward your goals using the online member portal.
  • Avant This lender offers personal loans to borrowers with less-than-perfect credit. Most Avant customers have credit scores between 600 and 700. You can also check to see if you qualify and explore your rate options without affecting your credit.
  • LightStream This online lender offers potential low rates with its Rate Beat program. The program guarantees that if you’re approved by another lender for a lower rate on an unsecured loan, LightStream will beat it by 0.10%. Restrictions apply, and you’ll need a good to excellent credit profile to qualify for a LightStream loan.
  • Wells Fargo This national bank can send payments directly to third-party creditors within one to three days to help you refinance your debt. This can speed up and simplify the refinancing process.

Potential disadvantages of refinancing a personal loan

Before deciding to refinance your personal loan, it is important to consider the potential pitfalls of refinancing.

A lower interest rate doesn’t necessarily mean more savings

If you’re refinancing for a longer loan term, one potential disadvantage is paying more interest, even with a more attractive interest rate. A longer loan term means you’re paying interest for longer, too. Your lower monthly payments could come with a higher total interest price tag over the life of the loan.

Here’s an example involving a $10,000 personal loan with a 15% interest rate and 36-month term versus a $10,000 personal loan with a 13% interest rate and 60-month term.

  • The 36-month/15% loan adds up to a monthly payment of $346.65, with total interest at $2,479.52 over the life of the loan.
  • The 60-month/13% loan offers a lower monthly payment of $227.53. Yet the total interest over the life of the 60-month/13% loan comes out to $3,651.84 — because the borrower will be paying interest for a longer amount of time.

While the 13% loan provides a longer term and lower payment, it also bumps up the total interest paid by $1,172.32, making it less attractive in the long run.

Fees that can add up

Some personal loans hit you with extra costs, such as origination fees or prepayment penalties. If you face both, it would mean you have to pay a fee to end the old loan and more to begin the new one.

Even if your new loan has a much lower interest rate than the one you’re refinancing, origination fees could mean paying more over the entire loan term. So when you’re comparing terms between your existing personal loan and a new one, be sure to consider any origination fees and prepayment penalties, along with any additional fees and APRs.

The interest rate — in the form of a percentage — is the cost the borrower pays to borrow the money. Meanwhile, the APR is the annual cost of the loan for the borrower. The APR for a loan combines the interest rate with fees and other added costs to give you a clearer picture of how much you’re paying for a loan over the course of a year.

How to refinance a personal loan

If you’ve weighed the pros and cons and are ready to continue on your refinancing journey, here are some steps you can take.

1. Shop around

Just like when you’re looking for a credit card or a mortgage, you should shop around to compare loans when seeking to refinance a personal loan. This way, you can help ensure you’re getting the lowest interest rate you can qualify for, along with the most-favorable payoff period and manageable monthly payments.

Tip: Be sure to ask the lender that handles your existing personal loan whether it could refinance the loan. Or consider shopping for personal loans online through websites like Credit Karma.

2. Research the reputation of lenders

Every year, the Consumer Financial Protection Bureau receives consumer complaints related to installment loans. Some of those consumers report being told conflicting information about documents and other application requirements. Meanwhile, other consumers complain about being hit with interest charges or fees that they hadn’t expected.

Do some digging to help avoid being surprised by fees or terms, especially when looking to deal with online personal loan lenders. With a little research online, you can find reviews from the Better Business Bureau and other sources that might help you consider which lenders you want to do business with.

3. Check your credit scores

Before you decide on the right offer to refinance your loan, check your credit scores so that you know where you stand. Typically, people with higher credit scores are more likely to qualify for lower interest rates. And lower credit scores generally equate to higher interest rates.

If you aren’t sure where your score falls, we offer a guide to credit score ranges.

4. Figure out the fees

An online loan calculator can help you determine how extra costs like origination fees and prepayment penalties can affect the cost of repaying the refinanced loan.

As we mentioned earlier, these fees can increase the total cost of a loan so that even a refinanced loan with a lower interest rate might mean you end up paying more in the long run.

5. Consider prequalification for a personal loan

Prequalifying for a personal loan — a less formal assessment of your credit — doesn’t guarantee you’ll get a personal loan to refinance your existing one. But it could help you get an idea of your ability to qualify for a loan before you go through an application — and before you potentially harm your credit with a hard inquiry on your credit reports. It can also help you understand if you’ll be able to borrow enough to pay off your existing loan and what interest rate you might get.

6. Fill out the application

Once you’ve shopped around, done the math and prequalified, it’s time to apply for refinancing. This process will likely be similar to how you would have applied for your personal loan in the first place.

This is where your research and prequalifications can pay off. When you apply for credit, the lender will typically check your credit reports, which results in a hard inquiry. Multiple hard inquiries in a short period could give lenders the impression that you’re a higher credit risk, so be careful about how many lenders you apply to.

That said, it’s good to keep in mind that the impact of a hard inquiry on your credit shrinks over time.

Could refinancing hurt my credit scores?

Since refinancing means you’re getting rid of an old loan and taking on a new one, you may see a dip in your credit scores. There are a few reasons this could happen.

  • Hard credit check — Lenders will perform a hard inquiry to check your credit history and scores when you apply for a refinance loan. This inquiry can result in a slight drop to your credit scores. When shopping around for a refinance loan and applying with several lenders, try to submit your applications within a 14-day period. Many, though not all, credit-scoring models consider multiple inquiries within a 14-day window as just one inquiry, which will minimize the effect on your credit scores.
  • Account closing — Your original loan will be closed after the refinancing goes through. Under some credit scoring systems, loans for paying off debt can be viewed as a negative in ways that home or car loans aren’t. Also, credit-scoring models consider the length of the accounts on your credit reports. Some credit-scoring models will consider the old loan when determining the average age of your accounts, but other credit-scoring models won’t — meaning the average age could go down for those. FICO, a provider of credit-scoring models, says the length of your credit history represents 15% of FICO® credit scores
  • New credit — If you’ve recently applied for and taken out other loans or credit, your credit scores could take a hit. Credit-scoring models consider several new accounts within a short time period a greater risk.

But don’t overlook a potential upside of refinancing: If refinancing your personal loan makes it easier for you to make your monthly payments, and ultimately pay off the loan, those actions can positively affect your credit over the long term. Payment history accounts for about 35% of your FICO® scores, and the amount you owe on credit accounts determines 30%.

Next steps

As we laid out above, if you’ve got a personal loan and you’re weighing whether to refinance it, be sure to compare the pros and cons, including interest rate and any fees or penalties associated with ending one loan and opening another.

In the end, this comparison should help you figure out whether refinancing will save money, decrease your monthly payments or both. If you’ve determined that refinancing will benefit you, then make sure you check your credit scores, study the interest rate and fees for the new loan, and think about how refinancing can affect your credit.

About the author: John Egan is a blogger, content marketer and freelance writer in Austin, Texas. He is former editor in chief at Austin-based startup LawnStarter, and he previously worked at the Austin Business Journal, Bankrate and S… Read more.