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How And When To Refinance A Personal Loan

Holly Shuffett10-Minute Read
February 25, 2022

When it comes to the process of refinancing, chances are you’re more familiar with what it means to refinance a car loan or most likely, a mortgage on a home. But when it comes to refinancing a personal loan, you may have a few unanswered questions – like, given that they’re an unsecured loan type, is it even possible to refinance a personal loan

The short answer: Yes! In this article we’re going to be breaking down exactly how you can refinance a personal loan, when it may – or may not – be a good idea for you to do so, and how the decision to refinance may be able to help you achieve your own financial goals. 

How To Refinance A Personal Loan

Much like how you would refinance a mortgage or any other loan type, refinancing a personal loan operates in essentially the same way. When you refinance a personal loan you are replacing your existing loan with a new one – usually one with better interest rates or a revised repayment term. Typically, the hope of refinancing a personal loan is to pay less interest over time or get your debt paid off more swiftly. 

You’re likely able to apply for a refinance through your current lender – just be sure to understand their restrictions. You may also always seek out a new loan with a different preferred lender should you choose. The terms of your refinance will largely depend on these factors:

  • The borrower’s credit score
  • The borrower’s employment status and income
  • In some cases, the borrower’s education 
  • The borrower’s debt-to-income ratio 
  • The borrower’s standing with their current lender
  • The term of the loan
  • The loan principal 

Although it’s called a personal loan refinance, you are essentially taking out an entirely new loan, so you should expect to undergo the application process just as you did with your original loan. This means submitting applications and providing lenders with your financial information.

It’s also important to do just as much research and shopping around for the best rates and lowest fees available, just as you might have with your original personal loan. You should also be sure that refinancing is the best option for you in the first place.

Before accepting the terms of your refinance, you will be able to review your current loan’s terms and interest rates. Keep in mind that you’re free to continue making payments on your original loan should you decide that’s what’s best for you and your financial situation.  

What Happens When You Refinance A Personal Loan?

When you refinance a personal loan, you take out a new loan to secure a lower interest rate, better loan term, or lower monthly payments. A refinance is an entirely new loan, but one which allows you to roll your existing debt into terms that better fit your budget and financial plans.

Upon refinancing, it’s likely that you’ll reap some of the following benefits: 

  • You can get a better loan term: Maybe at the time of your original loan you only qualified for something more long-term. With refinancing, you can apply for a shorter-term loan, which usually comes with better interest rates and won’t have you carrying debt for an extended period of time 
  • You can secure a lower interest rate: Perhaps the most common motivation behind any refinance is the enticement of better interest rates. Assuming that you haven’t changed anything else about your loan, a lower interest rate can still help you get your debt paid off faster or simply afford you a lower monthly payment 
  • You can lower your monthly payments: Speaking of – if you’ve hit some financial speed bumps, extending your loan’s repayment term can help you keep those monthly payments low. In this case, however, you’ll want to keep in mind that you may wind up paying more in the long run due to making these payments for a longer period of time
  • You can repay the loan faster: On the other hand, if you’re in a good place financially, refinancing your loan to a shorter repayment period could get your debt paid off more efficiently and save you money on interest

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When Should You Refinance Your Personal Loan?

Although refinancing brings quite a few benefits to the table, maybe you just feel too comfortable with your current loan. Change can certainly feel intimidating – especially when it comes to things as daunting as finances and repaying debt. 

To see if refinancing a personal loan could save you money or lower your monthly payments, let’s explore some instances when refinancing just makes more sense than sticking it out with your current loan. 

Interest Rates Are Lower 

The interest rate you pay on your current personal loan was based partly on the market rates at the time of your application. The market is dynamic and constantly changing - sometimes to your benefit. If market interest rates are significantly lower than your existing rate, refinancing your loan will allow you to take advantage of these lower rates and save you some serious cash.

Your Credit Score Has Improved 

Your credit score is one of the main determining factors for personal loan terms, and the lower your credit score, the higher the interest rate you’ll be expected to pay. So if you’ve seen some serious improvement in your credit score since taking out your original loan, refinancing may be the way to go.

When your credit score has improved, you’re more likely to qualify for more favorable refinanced loan terms – including a lower interest rate, regardless of the current state of the market. 

You’ve Paid Off Other Debts 

Your debt-to-income ratio (DTI) is another factor which plays a substantial role in the terms of your personal loan. So if you’ve recently paid off existing debts and lowered your DTI, refinancing may be a good idea. Much like with improved credit, an improved DTI may provide you with better loan terms and more attractive interest rates. 

You’re Ready To Pay The Loan Off Faster

When originally applying for a personal loan, you agreed to follow a particular repayment schedule and have your loan repaid in full by a specific date.

But if you’re able and interested in saving yourself some money, refinancing can give you the opportunity to take out a loan with a shorter term or repayment period. This cuts down on the amount of time that interest can accumulate and puts some money back in your pocket. 

When Shouldn’t You Refinance?

With everything that refinancing has to offer it can seem like a no-brainer to start applying. In reality, refinancing isn’t a one-size-fits-all solution and it isn’t always the best option for every borrower. To get a better sense if refinancing a personal loan is right for you, let’s look at a few instances when refinancing might not be the best fit for you at the moment. 

You Can’t Afford The Fees 

Unlike a home equity loan which is backed by the value of a home, personal loans usually aren’t backed by anything, making them an unsecured loan. Because of this, it’s typical for personal loans to include an origination fee – a fee charged by the lender for issuing the loan. 

Origination fees cover the costs of processing your loan application, the underwriting process, actually financing the loan, and other services involved in the lending process. Usually between 1% and 10% of your loan amount, it’s important to keep an eye on this fee to ensure that a refinance would be worth it to you. 

Even if a personal loan refinance can offer you a much lower interest rate, if the burden of origination fees or other penalties outweighs or barely equals the benefits from a new rate, sticking with your original loan may be a much better option. 

Here are the fees you can expect and plan for when refinancing a personal loan:  

  • Origination fees
  • Application fees
  • Prepayment fees or penalties 

Although not all loans have it, a prepayment penalty is a fee that you may be met with should you pay off your debt before the end of your loan term. Though it may seem counterintuitive – paying off debt is good, right? – since refinancing a loan requires that you pay off your existing balance (and then replace it with the new loan), you’ll want to check the terms of your current loan and understand the financial penalties that may come with paying it off early. 

Your Credit Score Has Dropped 

Lenders will review your credit score during the underwriting process, a step in the lending process which doesn’t change regardless of whether it’s a new loan or a refinance. And personal loans are notorious for being difficult to qualify for with damaged or weak credit, so if your credit score is lower than when you applied for your original loan, you likely won’t get a better interest rate or loan term. 

You Have More Debt Than You Used To 

With all of the curve balls that life can throw our way, it’s easy to take on different types of debt over time. If you’ve accumulated some new debts since your original personal loan, refinancing may not bring you many benefits if any. Take a look at your financial situation and see if you’ve recently taken on any of these debts: 

  • New credit card debt
  • Mortgage loans
  • Auto loans
  • Additional personal loans
  • Medical debt
  • Student loans
  • Bank overdraft charges
  • Payday loans

It’s important to carefully review your debt levels before deciding whether to refinance your personal loan. If you have significantly larger amounts of debt than when you applied for your original loan, you likely won’t qualify for any new rates or terms that could save you money.

Take a deep breath and focus on paying off your debts – a refinance could always be a good option for you down the road, maybe just not right now. If you’re feeling overwhelmed managing your debt, here are a few strategies that may be able to lower your DTI:

  • Pay off small debts: Try to eliminate monthly payments and if you can, pay off your smallest outstanding debts in full
  • Diversify your income: Finding a side hustle, picking up some more shifts, or freelancing are great ways to bring in some extra cash and lower your DTI. For your lender to view this income as consistent and legitimate, however, you will likely need to prove a 2-year history for each income source
  • Explore loan forgiveness: Though inapplicable to private loans, certain federal loans may offer varying degrees of loan forgiveness. Most common for student loans, loan forgiveness qualifiers include things like performing volunteer work or working in the education, legal, or medical fields
  • Extend your loan periods: Though it’s not a great long-term plan, in some cases extending the duration of a loan is a sure-fire way to lower your monthly loan payments. This can be a good short-term solution if you have a steady income or anticipate positive changes to your income, but with higher interest rates to compensate for an extended repayment period, this tactic will have you paying more over time

Although it can feel scary to be in debt, it’s important to remember that DTI isn’t everything and it certainly isn’t always the best indicator of your financial health. In fact, given that you can meet your monthly payments, some debts – for example, a mortgage, especially if you’re a first-time home buyer – may be seen as positive, since they show that you are building a financial future. 

What To Consider When You’re Ready To Refinance

Before making the decision to submit your applications and get prequalified for a personal loan refinance, there are a few more things that you should consider. Let’s explore them to determine if a refinance is truly the best choice for you: 

How Much Money You Need 

One of the most significant benefits of refinancing a personal loan is the fact that you are able to refinance the full repayment amount for your original loan. Before you apply, it’s important that you know how much this repayment amount will be so that you ask for the correct amount of money from your lender at the start.

Review your original loan terms and make sure you won’t be surprised by any fees, repayment penalties, or other costs that you’ll be expected to cover with a refinanced loan. 

Your Relationship With Your Current Lender 

Not all lenders are created equal. Some lenders may allow borrowers who are in good standing to refinance with them, rather than go out and find a whole new lender. If this is a possibility for you, it’s a smart one! 

Refinancing through your current lender can save you money and make the application process significantly easier – and potentially faster – since your lender will already have accessed your financial documents. However, if you are delinquent on your loans or have simply been left unsatisfied with your current lender’s services, don’t shy away from getting quotes from other lenders or exploring further options. 

Your Credit Score

Since a refinance is still technically an entirely new loan, the refinance process will involve an updated credit check – something which can cause your credit score to drop, at least temporarily. It’s best to review your credit scores prior to application or refinance to ensure that you’re happy with where you’re at and that your credit score can tolerate a bit of a dip.

Remember, if your credit score drops too low or if you’re going to be purchasing a car, home, or any other high-price item that will also involve a credit score check, you may be better off waiting to refinance. 

Additionally, you should know the status of your credit score to properly gauge if a personal loan refinance will be beneficial to you in the first place. If your credit score won’t qualify you for a lower rate than the one you’re currently paying, save yourself the trouble – and money from fees and repayments – and simply stick with your original loan. 

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The Bottom Line

Like any big financial decision, the choice to refinance a personal loan is one that’s unique to you and your financial needs. For some of us, refinancing is a great way for qualified borrowers to save money and get better loan terms, which can make repaying the loan faster and easier. For others, refinancing may not save you all that much when you factor in the origination, application, or prepayment fees that you may be met with.

Whether refinancing your personal loan is a good idea all depends on your current financial health. Have you seen recent improvement in your credit score or made some serious headway on paying off debts? Are the current market rates significantly lower than your current loan rate?

Before starting the application process, take a good look at your personal financial situation and consider whether refinancing is truly in your best interest – if it is, get started today and apply online with Rocket Loans℠.

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Holly Shuffett

Holly Shuffett is a staff writer who writes with a focus on homeownership and personal finance. She has a B.A. in public relations from Oakland University and enjoys creative writing and reading in her free time.