Can you refinance a personal loan?

What is a personal loan?

A personal loan is financing consumers can use for almost any purpose; the loan is then repaid in fixed monthly payments. Some personal loan companies offer repayment terms as short as six months, while others may give you up to 84 months to repay. You may be able to get a personal loan as small as $250 from some lenders or as large as $100,000 from others

Most personal loans are unsecured, meaning you don’t have to pledge collateral, like your car or home, to your lender. Most people apply for a personal loan online. While funding may be available as soon as the day you apply, it could take up to a week to receive the money.

» MORE: Best personal loans with a co-signer

How do I refinance a personal loan?

Refinancing a personal loan is a simple process of finding and comparing lenders, filling out an online application, getting approved and having your new lender pay off your existing loan. The process is not much different from getting a new loan, except the loan proceeds will be used to pay off existing debt rather than for another purpose.

When you refinance a personal loan, the lender should directly pay off your existing loan.

Most lenders specializing in personal loan refinances or debt consolidation will directly repay your existing lender with the loan proceeds once your loan is approved. Lenders that allow you to use personal loan proceeds for any purpose may allow you to pay off existing debt on your own using the loan proceeds. Ask your lender how the payoff process works when you apply.

As you consider refinancing your personal loan, talking to your existing lender might be a great place to start.

“The lender might be willing to negotiate the rates and provide you with a better deal than your current loan,” said Levon L. Galstyan, a certified public accountant with Oak View Law Group in Auburn, California. “Inform your current lender that you’re thinking about refinancing your personal loan. Find out … the amended rates and terms they are ready to provide.”

When should I refinance a personal loan?

You should consider refinancing your personal loan if you think you may qualify for a lower rate, you need to lower your monthly payment, you want to change from a variable rate to a fixed rate or you want to access additional cash.

Before refinancing, compare benefits and costs, including fees and what you’ll pay long-term in interest.

When you refinance your personal loan, you might be able to lower your monthly payment by receiving a lower interest rate, getting a longer repayment term or both. Remember that you might pay more interest over time if you extend your repayment term.

If your existing personal loan has a variable interest rate, you can refinance your loan to get a fixed rate instead. With a fixed-rate loan, your payment and interest rate will never change. As a result, you’re protected from future rate and payment increases. However, remember that your rate also won’t change if interest rates decrease in the future.

You might want to refinance your personal loan if your credit score has improved, as you may be able to qualify for a lower rate and reduce your interest costs. Plus, you could potentially use a refinance to access additional cash.

“Say you need to pay for a car repair but already have a $500 loan,” said Galstyan, the accountant at Oak View Law Group. “Assuming there are no origination or other fees, if you refinance to obtain a new loan for $1,000, you will have $500 to pay down your existing loan and another $500 to use for expenses.”

Ultimately, you should only consider refinancing a personal loan if the benefits outweigh the costs.

» MORE: Are personal loans taxable and considered income?

When shouldn’t I refinance a personal loan?

You shouldn’t refinance your personal loan if you can’t qualify for better rates or terms, if you’re about to apply for a mortgage or if the costs outweigh the savings. If you’re not benefiting from the transaction, it doesn’t make sense to go through with the refinance.

One of the main reasons people want to refinance their personal loans is to get better rates and terms. Refinancing is usually pointless if you can’t qualify for a better personal loan. Similarly, some lenders charge upfront personal loan origination fees. Before going through with the transaction, ensure the savings or benefits you’ll receive are more than the fees you’ll pay.

Additionally, you shouldn’t refinance your personal loan if you plan to apply for another loan soon, such as a mortgage to buy a house. When you apply for a personal loan, your credit score may temporarily decrease because the lender will do a hard credit check. Plus, your new lender will be able to see you recently applied for a loan and might question whether you were having difficulty making your existing payments.

Pros of refinancing a personal loan

The pros of refinancing a personal loan can include the following:

• Lower monthly payments: Your monthly payment might go down if you get a lower rate, a longer repayment term or both on your new loan. This can be helpful, as it offers more room in your budget to cover other costs.
• Lower interest rate: If rates have decreased since you got the loan, or your finances have improved, you may qualify for a better rate. Depending on the terms of your personal loan, this may result in lower payments and overall borrowing costs.
• Debt consolidation: You might be able to use a personal loan refinance to consolidate your other debts. Not only might your interest costs be reduced if you pay off higher-rate debt, but you’ll also only have to pay one monthly bill.
• Faster debt payoff: If you choose a shorter repayment term when you refinance your personal loan, you’ll be able to pay off your debt faster while saving on interest.

When you’re considering whether you should refinance a personal loan, your main consideration is how you benefit financially. If the benefits of refinancing the personal loan don’t outweigh the costs, you’re better off keeping your existing loan.

Cons of refinancing a personal loan

The cons of refinancing a personal loan vary, depending on your situation.

• Possible prepayment penalty: Depending on the terms of your existing loan, you might have to pay a prepayment penalty if you repay your existing loan early. Check with your lender or review your loan documents to understand potential fees before refinancing.
• Origination fee: Some lenders charge origination fees on new loans, which are upfront fees intended to cover the costs of processing and funding your loan. You should be sure the long-term savings you’ll receive outweigh any upfront costs before proceeding.
• More interest over time: You may pay more interest over time if you extend your repayment term or your interest rate increases with the refinance. As with the origination fee consideration, before going ahead, make sure to consider whether the benefits you’re receiving (like a lower monthly payment) are worth the long-term costs.

Another consideration when you’re refinancing a personal loan is the impact on your credit score. The lender will perform a hard credit inquiry, which temporarily lowers your score. Still, as long as you make payments on time (and don’t have other issues with credit), your score will recover — and even improve.

Bottom line

It’s relatively simple to refinance a personal loan. The process you’ll follow for the refinance is the same as getting a new personal loan, except you’ll use the loan proceeds to pay off your existing debt versus using it for another purpose. Some lenders will pay off your existing debt for you, while others will give you the funds and allow you to pay off the debt on your own.

Refinancing a personal loan can be a great way to pay off debt and save money — as long as the benefits you receive from the refinance outweigh the costs. For example, you might determine the long-term interest savings are greater than the upfront fees you need to pay to get the loan.

Be certain to consider both the pros and cons before deciding to refinance your personal loan. It doesn’t make sense to go through with a refinance if you can’t get better rates or terms or if you are applying for a mortgage soon. If the analysis ends up in your favor, refinancing a personal loan is a decision that can put you in a more favorable financial position.