Can you refinance a personal loan?

What does it mean to refinance a personal loan?

When you refinance a personal loan, you take out a new loan to pay off your existing one. You may use the same lender or choose a new one, but the goal is to get loan terms that better fit your current needs. That could mean a lower interest rate, which can save you money; a longer term, which can reduce your monthly payments; or a shorter term, which can help you pay off the loan faster.

Refinancing isn’t always ideal for everyone. It can affect your credit score and, depending on the new loan’s fees and terms, it might not save you money.

When should you consider refinancing a personal loan?

There are times when refinancing a personal loan is a good idea.

Taylor Kovar, the founder and CEO of 11 Financial in Lufkin, Texas, told us: “You might want to look into refinancing a personal loan if your credit score has improved or if interest rates have come down since you first took out the loan. Some people also consider it when they need to free up monthly cash flow or want to combine a few debts into one.”

Here are some common situations in which refinancing makes a lot of sense:

• If your credit score improves: A better credit score could qualify you for a lower rate, which means lower interest and potentially smaller monthly payments.
• If you’re struggling with monthly payments: Extending your loan term can help reduce what you owe each month, but you’ll likely pay more interest over time.

  Even so, Kovar told us, getting a longer term may still be worth it. “It’s probably worth weighing the pros and cons, especially if lowering the monthly payment could help reduce stress, even if it means paying more in interest over time,” he said.

• If you want more predictable payments: Some loans have variable rates that can go up and down throughout the life of the loan. Refinancing into a fixed-rate loan keeps your payment steady.

There may also be times when refinancing isn’t optional — for example, if you need to remove a co-borrower during a divorce. In those cases, the new loan may come with less favorable terms, but the refinance may still be necessary.

That said, when refinancing is a choice, it’s worth comparing the new loan to your current one to make sure it puts you in a better position, whether that means locking in a lower rate, lowering your monthly payment or adjusting your loan term.

» MORE: Need help calculating your new loan interest?

Pros and cons of refinancing a personal loan

Here are some possible pros and cons of refinancing a personal loan, depending on current market conditions and the rates and terms you qualify for:

How to refinance a personal loan

If you’re ready to refinance a personal loan, here are some steps you should take before you apply:

Determine how much money you need

You’ll probably need to borrow more than your current loan balance to cover refinancing costs. Start by asking your lender for a payoff quote; this includes the remaining balance plus any interest that’s accrued since your last payment. Also check for prepayment penalties or early payoff fees that could add to the total.

Then, look at the terms of the new loan. If there’s an origination fee, make sure to factor that in when deciding how much to borrow.

Check your credit score and credit report

Lenders check your credit score to decide if you qualify and what rate to offer. Most personal loans require a minimum score, so it’s smart to review your credit before applying.

Be sure to get a free copy of your credit report so you can review your credit history for errors. The best rates typically go to borrowers with excellent credit (781 to 850), but some lenders offer bad credit loans at higher interest rates.

Compare rates and terms

You’ll want to compare factors like interest rate, term and credit requirements before settling on a lender. Don’t forget to look for any fees that may apply, such as origination fees or prepayment penalties.

Once you narrow down your list, visit each lender’s website to see if you prequalify. Since prequalification typically involves a soft credit check that doesn’t affect your credit, you should be able to get an idea of what rates and terms the lender can offer.  Lenders like Upgrade and Best Egg offer a convenient prequalification tool right on the homepage.

» FIND: The best rates and terms

How refinancing a personal loan affects your credit

Refinancing means taking out a new loan, which involves a hard credit check. This can cause a small, temporary dip in your credit score. Over time, making consistent payments on the new loan can help your score recover.

A refinance may also affect the length of your credit history. Refinancing closes your old loan and opens a new one, which can shorten the average age of your credit accounts. This factor makes up about 15% of your FICO score, but as you keep the new account open and avoid taking on new credit, your average account age will increase again.

“Refinancing a personal loan can have both short- and long-term effects on your credit,” said Chris Ross of Southwest Title Loans. “However, over time, refinancing can improve your credit by reducing your debt-to-income ratio and helping you make more consistent on-time payments — especially if the new loan terms are more manageable.”

A short-term dip in your credit score isn’t always a bad thing, especially if refinancing helps you stay current on payments or improve your financial habits. “If it helps you stay on top of payments or pay things down faster, it might work in your favor over time,” Kovar said. “Everyone’s situation is different, so it just depends on what your priorities are right now and what would make the biggest impact on your overall financial health.”