- If you improved your credit score since taking out your original personal loan, you may benefit from refinancing, especially by securing a lower interest rate.
- Refinancing personal loans can also help you with consolidating to a single monthly payment or switching to a more affordable repayment term.
- There are also potential negative consequences of refinancing, including fees and effects on your credit.
Personal loans can be used for a wide variety of reasons and can come with varying interest rates and repayment timelines. Which is why at some point you may decide that refinancing a personal loan is a good idea.
“If you refinance your personal loan, you might be able to decrease your loan payments from the lower interest rates available,” says Mark Stewart, a Certified Public Accountant. “In addition, you can get a faster repayment time, which helps you get out of debt as fast as possible.”
Keep reading for more insight into how to refinance personal loans and what the pros and cons of doing so are.
Inside this article
How to refinance a personal loan
Understanding how a personal loan refinance works can help you determine if it’s the right financial move for you or not.
Refinancing a personal loan involves taking out a new loan to pay off the original debt. Then that new loan is the one you will focus on repaying. You can refinance a personal loan through a variety of different financial institutions such as a bank, credit union or online lender.
Funding for personal loans can be quick: After your application is approved, you can expect to receive the loan funds within one to five days—or even as soon as the next business day. Some lenders may offer to pay off your loan for you, in which case the new loan funds wouldn’t actually appear in your account. Other lenders would disburse the refinance loan directly to the bank account of your choice.
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Why you might want to refinance a personal loan
Before you refinance a personal loan, it’s important to weigh the advantages and disadvantages of such a move.
- Lower interest rate: If you have a higher credit score now, you may be able to qualify for a lower interest rate that can save you money.
- New repayment term: If you want lower monthly payments, you can apply for a longer repayment term, but if you want to save money on interest, you can apply for a shorter repayment term.
- Larger loan amounts: You may be able to qualify for a new loan that can repay your original loan and that can give you access to extra funds.
- Stable interest rate: If you currently have a personal loan with a variable interest rate, you can apply for a fixed interest rate which will stay consistent over the life of the loan.
- Prepayment penalties: If your original loan has a prepayment penalty, refinancing your loan can cost you an additional fee as you will use the new loan to pay off your old loan early.
- Origination fee: Another fee you need to look out for when applying for a new loan is an origination fee, which can be 1% to 8% of the loan amount, depending on the lender.
- Extending loan terms leads to more interest: If you choose a longer loan term to secure smaller monthly payments, you’ll likely end up paying more in interest over time.
- Damaged credit score: Applying for a new loan leads to a hard credit inquiry that can temporarily lower your credit score.
Steps to refinance personal loans
While the exact process of refinancing personal loans can vary a bit depending on the lender you choose to work with, you’ll generally take these seven steps.
1. Determine how much you need to borrow. Before you can refinance a personal loan, you’ll need to figure out the exact amount you need to borrow to pay off your loan in full, including fees such as prepayment penalties.
2. Review your credit score and report. You need to determine if your credit score is higher or lower than when you took out your original personal loan. Remember—a higher credit score is usually necessary to secure a more favorable interest rate. You also need to review your credit report. That way, you can fix any errors on the report that are harming your credit score.
3. Shop around. Take your time comparing different lender options to determine which bank, credit union or company is most likely to offer you the best interest rates and a low or nonexistent origination fee, plus a repayment term that will work best for you. You can prequalify with different lenders to get an idea of what their loan terms would be before you officially apply, which can negatively impact your credit score.
4. Pull necessary documentation. Usually, lenders want to see documents that prove your identity, residence and income—such as a Social Security card or W-2 form—during the application process.
5. Complete applications. Now it’s time to apply for a personal loan. Some lenders allow you to apply online and others require in-person applications. Approvals can happen quickly—as fast as just a few minutes.
6. Pay off your original loan and confirm account closure. Some lenders will work with your creditors to pay off the original loan when you refinance, and some will deposit the funds into your bank account, allowing you to pay it off yourself.
Once you pay off your original personal loan, request that your former lender provide a paid-in-full letter. Then check your credit report to verify the loan has been paid and the account is closed. Taking these additional steps will ensure your debt is done for good.
7. Start making payments on the new loan. Now, you need to turn your attention to your new personal loan. Confirm your payment amount and the first due date as soon as possible to ensure you don’t accidentally miss a payment. Setting up automatic payments could come with rewards like a discounted APR.