When To Refinance A Personal Loan: A Guide
Are you having trouble making your personal loan payments? Or maybe you're looking for lower interest rates, fixed interest rates or want to avoid a balloon payment. If this sounds like your situation, may want to opt for a refinanced personal loan.
Let's take a look at how to know whether refinancing a personal loan is right for you (and when to wait), how to refinance a personal loan and the pros and cons of a personal loan refinance.
Can You Refinance A Personal Loan?
Can you refinance a personal loan?
Yes, you can refinance a personal loan. But first, what exactly is a personal loan and what is a personal loan refinance? You can borrow money from a lender in the form of a personal loan and use it for a variety of reasons, including paying for large purchases, consolidating debt, paying for emergencies and more. You'll pay back a personal loan with interest. The amount you pay for interest is a percentage of your loan amount.
Personal loans are unsecured, which means borrowers don't put up anything as collateral, such as a house or car. Secured loans require collateral to back the loan, which means that the lender can take away the item you put up as collateral if you fail to make payments. Personal loans may be lent for 12 – 60 months and in some cases, longer.
A personal loan refinance means that you take out a new personal loan in order to pay off the old one. You'll get a new rate and a new loan term for this refinance. Compare and contrast personal loan refinances and note that not all lenders allow refinances for their own loans.
How To Know If Personal Loan Refinancing Is Right For You
People take out different types of personal loans at different times in their lives. There are several reasons you may want to refinance, including:
- Lower interest rates: When interest rates go down, a refinance might help you save money over the long term because you won't pay as much per monthly payment. Even a small interest rate reduction can save you money over the life of the loan.
- Fixed interest rate: Refinancing to a fixed rate might be preferable if you previously took out a variable-rate loan. A fixed interest rate is one that stays the same throughout the life of the loan, while a variable interest rate changes based on certain market conditions. You can depend on a fixed interest rate to stay the same, while variable interest rate payments can be unpredictable.
- Change in personal income: Refinancing your personal loan can also help if you are currently carrying a monthly payment you can’t afford. You may be able to lengthen the term of your personal loan, which makes the payment lower each month.
When To Wait On Refinancing A Personal Loan
It's important to weigh the costs and benefits when you're thinking about refinancing. In some cases, the timing might not be right to refinance your personal loan. Let's take a look at the types of situations in which it might not be the right time to refinance a personal loan:
- High interest rates: If you refinance while rates are high, you could end up paying more over the length of your repayment term.
- Poor credit: Refinancing with a low credit score could affect the interest rate you receive. You may want to consider boosting your credit score by not missing payments, catching up on past-due accounts, paying down revolving account balances (such as a credit card) and limiting the amount of credit you apply for.
- Prepayment penalties: It's a good idea to check on whether there is a prepayment penalty, a fee incurred if you choose to pay off your loan early. Borrowers should check with their original lender about prepayment penalties before choosing to refinance. Otherwise you could be charged for changing the terms of your loan too early.
How To Refinance A Personal Loan
Let's take a look at how to refinance a personal loan, step by step.
1. Check Your Loan Amount
First, check the exact amount you need to borrow on a new personal loan to pay off your original loan(s). Check on the total loan amount due as well as other major costs or fees that you may incur for paying off your original loan and securing your new loan, such as origination fees you may need to pay with your new lender. Origination fees are those charged by a lender to process a new loan application.
2. Check Your Credit Score and Credit Report
It's important to understand your credit score before refinancing because your credit score directly affects your interest rate. A credit score is a three-digit number that shows how well you handle debt. In order to get a preapproval for a loan, your lender may do a soft inquiry on your credit.
A hard inquiry, on the other hand, occurs when you give someone permission to check your credit. If you have poor credit, you may want to work on improving your credit score before refinancing so you can get the best interest rate possible on your personal loan refinance.
You can pull your credit report to check over your credit history. This is a summary of how you handle credit and to check for any inaccuracies prior to applying for a refinance. It’s a good idea to correct any errors before refinancing for the best results.
You are entitled to a free credit report every year from each of the three major reporting companies – Equifax®, Experian™ and TransUnion®. Report any errors to each reporting company prior to prequalifying for a new loan.
3. Prequalify For A New Loan
After checking your credit reports for errors, you can prequalify for a new personal loan. This is considered a soft credit pull, which won't affect your credit score. You will need to provide some information, such as your name, address, income, Social Security number and birthdate. Once preapproved, your lender will share rates, terms and personal loan amounts with you.
4. Compare Lenders and Loan Terms
Compare lenders and loan terms carefully. Banks and other lenders may offer different rates. Check for various fees associated with refinancing (such as origination fees) and how you might pay for them over the course of your loan term.
Note that you may want to contact your current lender to renegotiate the terms of your original loan, especially if you've enjoyed working with your current lender.
5. Apply for A New Personal Loan
Finally, you'll need to apply for your new personal loan, which may require you to supply your lender with your bank account information, identification, pay stubs, bank statements and more. Your lender will also ask permission to do a hard credit inquiry, which can deliver a small hit to your credit score. Your new lender will then pay off your old loans and you will eventually start payments on your new loan.
Pros and Cons Of Refinancing A Personal Loan
What are the pros and cons of refinancing a personal loan? Let's take a look.
Pros Of Personal Loan Refinance
Refinancing can be the right choice for many borrowers, and the benefits can include the following:
- One fixed payment: Refinancing can help you pay off multiple loans with one interest rate with one lender. If you want to simplify your payments or consolidate debt, this could be a great benefit because it helps you achieve one payment instead of several.
- Longer payment schedule: Refinancing can extend your loan payment schedule, which can benefit you if you prefer to extend your loan term.
- Lower monthly payments: Lower monthly payments can help borrowers who need to stick to a stricter budget. If you're feeling strained, a lower monthly payment could give you some freedom in your budget.
Cons of Personal Loan Refinance
Weigh the positive and negative factors when refinancing. Some potentially negative impacts of refinancing can include the following (though note that negative impacts might be balanced by the benefits of refinancing):
- Credit score impact: Taking out a personal loan can impact your credit score, especially when your lender does a hard credit pull.
- Extra fees: You may have to pay extra lender fees during the refinancing process, such as origination fees.
- Could pay more in interest: If you do opt for longer monthly payments, the downside is that you'll pay more in interest over the length of the loan term.
The Bottom Line
When you refinance a personal loan, you get a new loan with new terms and pay it back with interest. It's a good idea to consider the pros and cons of refinancing a personal loan before you decide it's an option for you.
The benefits of refinancing may include one fixed payment, a fixed payment schedule and lower monthly payments. On the other hand, the downsides include extra fees and facing a negative impact on your credit score. You may also pay more in interest over time.
Want to get started on refinancing your loan? Apply for a personal loan with Rocket LoansSM today.