You are now leaving our website and entering a third-party website over which we have no control.
10 Things to Consider Before Refinancing a Personal Loan
Key takeaways
- Compare your current rate to new offers that you receive by prequalifying. An improved credit score may unlock better refinancing terms
- Consider your remaining term and payment goals. A longer term may lower monthly payments but increase the total interest you pay overall
- Factor in any applicable fees and charges as you calculate a break-even point to see if refinancing will be worthwhile
Refinancing a personal loan means taking out a new loan to replace your existing one, typically with the goal of securing better terms. For some borrowers, a personal loan refinance can be a useful financial move. To determine how useful, we need to weigh the refinancing pros and cons.
Much will depend on your financial situation, so let's take a detailed look at what to consider before refinancing a personal loan.
1. Your current interest rate vs. the new rate
A good starting point for any decision on refinancing is a comparison of your loan's interest rate with current market rates.
Even a modest reduction in the interest rate could translate to real personal loan refinancing savings over time, especially if you still have a significant portion of your loan remaining.
Lenders look at a variety of factors to decide what personal loan refinance rates to offer, including:
-
Your credit score
-
Your income
-
Your debt-to-income ratio
-
The lender's current pricing
It's worth taking the time to compare personal loan refinance rates from multiple lenders before committing. Look for lenders who will allow you to prequalify for a loan so you can get more details on the loan terms you might be offered before you apply. The difference between prequalification vs. application is that prequalification involves a soft inquiry, which does not affect your credit score, while a formal application typically triggers a hard inquiry, which can have a modest, temporary impact on your score.
The next factor, your credit score, is closely related to the interest rate you might get on a new loan.
2. Your credit score has improved
If your credit score has improved since you took out your original loan, you may qualify for better terms than you did initially. Lenders tend to offer their best rates to borrowers with the highest credit scores and profiles. An improvement in your score could open up new options.
Before applying, check your credit score and your credit report for any errors that could be hurting your score. Correcting those errors is an easy way to improve your score. You can request a free copy of your credit report at Annual Credit Report.com. The report will give you information on how to contact the credit bureau of you do find an error that needs to be corrected in your favor.
Even a difference of a few percentage
3. The remaining loan term
The amount of time left on your current loan is another big factor. If you're nearing the end of your repayment period, the interest savings from refinancing may be minimal. Most of the interest on an installment loan is typically paid at the front of the loan.
The earlier in your loan term that you refinance, the more likely you are to hit a break-even point and start saving money.
Refinancing also gives you the option to adjust your loan term and monthly payment. You could give yourself a lower monthly payment by refinancing a loan with a short term into one with a longer term. Or you could go in the opposite direction.
You'll just have to consider the trade-offs. A shorter term could help you pay off the debt faster and pay less in total interest, though it would likely come with higher monthly payments. Extending the term could lower your monthly payment but may result in paying more interest over time.
4. Total cost of refinancing
The fees on personal loans vary widely depending on the lender.
When refinancing a personal loan, you may need to consider prepayment penalties on your existing loan as well as origination fees and other possible charges on the new loan. Before moving forward, calculate whether the savings from refinancing would be enough to offset these expenses.
One useful way to think about this focuses on the break-even point and savings. How long would it take for your monthly savings to exceed the upfront costs of refinancing? If you plan to pay off the loan before reaching that break-even point, refinancing may end up costing you more than staying with your current loan.
5. Your monthly cash flow needs
Refinancing can be a great tool for managing monthly cash flow. Let's say your budget has tightened since you took out your original loan. Refinancing to a lower monthly payment (either through a lower rate or a longer term) could free up room in your budget for other expenses or savings goals.
Extending your loan term to lower your monthly payment may increase the total amount of interest you pay over time. If your primary goal is to reduce what you pay each month, that may still be the right choice for your situation. Going in with a clear picture of the long-term cost can help you make a more informed decision. Conversely, if your cash flow has improved and you can afford higher monthly payments, refinancing to a shorter term could help you become debt-free sooner.
6. How refinancing impacts your credit score
As you're thinking about your options, don't forget the credit score impact of refinancing a personal loan.
Getting a new personal loan to replace an existing one could have an effect on your credit score. When you apply for a new loan, the lender will typically run a hard credit inquiry, which may cause a small, short-term dip in your score. Opening a new account can lower the average age of your credit history, which is another factor in many scoring models.
The most important factor on your credit score typically is making payments on time. If refinancing means you are more likely to never miss a payment, then it could help your score. The net effect of how refinancing affects credit will depend on your overall credit profile and how you manage the new loan going forward.
7. The reason you're refinancing
Finding a clear answer to "should I refinance a personal loan?" starts with assessing your goals. Typical reasons that people refinance personal loans include:
-
Secure a lower interest rate
-
Reduce monthly payments
-
Use a debt consolidation refinance to combine multiple debts into a single loan
-
Remove a co-signer from the original loan
Each of these goals may lead to a different refinancing strategy. Some may be more straightforward to achieve than others.
If you're refinancing primarily to save money on interest, focus on the total cost of the new loan compared to what remains on your current one. If you want to consolidate debt with a refinance, consider whether the new loan's rate and terms actually improve your overall situation. And if you're refinancing to lower monthly payments during a period of financial strain, make sure the new payment will be sustainable for your budget over the full term of the loan.
8. Whether you qualify for better terms
Not every borrower will qualify for better terms when refinancing. Lenders evaluate your creditworthiness based on a combination of factors, including your credit score, income, employment stability, and your debt-to-income ratio.
If your financial profile hasn't changed significantly, you might still qualify for better terms if interest rates in general have gone down. Shop around and compare personal loan refinance rates from multiple lenders before deciding. Prequalifying with several lenders using a soft credit check can give you a sense of the rates and terms you might realistically qualify for, without affecting your credit score in the process.
9. Timing and loan payoff strategy
Refinancing is often most advantageous when you're earlier in your loan term, since more of your remaining payments are going toward interest at that stage. If you're already well into repayment and the bulk of your interest has been paid, the financial benefit of refinancing may be more limited.
If you have other high-interest debts, your personal loan payoff strategy might shift toward paying them off as soon as possible rather than refinancing a loan that already has a manageable rate.
Thinking through how refinancing fits into your overall strategy, rather than evaluating it in isolation, can help you make a more well-rounded decision.
10. Whether you plan to borrow again soon
If you anticipate applying for another loan in the near future, it may be worth considering how refinancing could affect your credit profile in the short term. Applying for a new loan triggers a hard inquiry and adds a new account to your credit report, both of which can have a modest temporary impact on your credit score.
If a major borrowing need is coming up soon, you may want to hold off on refinancing until after that application is complete. On the other hand, if refinancing would significantly improve your financial situation (by lowering your debt load or monthly obligations) it could potentially strengthen your overall credit profile over time, which might be beneficial for future borrowing.
The right timing will depend on your specific circumstances.
FAQs
Knowing when to refinance a loan often comes down to a few key conditions:
- Your credit score has improved since you took out the original loan
- Interest rates have dropped
- Your financial situation has changed and you need a lower monthly payment
A debt consolidation refinance may also be worth considering if you want to combine multiple debts into one. Generally, the earlier you are in your loan term, the more potential benefit there may be. Comparing the total cost of the new loan against your current one is an important first step.
The credit score impact of refinancing a personal loan is typically modest and temporary.
Applying for a new loan could have a small, temporary impact on your credit score because lenders usually do a hard credit inquiry at that point. Shopping around using prequalification tools that rely on soft inquiries can help you compare options without affecting your score.
A new loan also could lower the average age of your credit history, which also could have a minor impact.
On the positive side, making payments on time is typically the most important factor on your credit score. If refinancing helps you to do that, then it could have a positive effect.
The potential for personal loan refinancing savings depends on several factors. A lower interest rate can reduce the total amount of interest you pay, particularly if you have a significant portion of your loan term remaining.
However, refinancing fees on a personal loan (like origination fees) could offset some of those savings. Calculate your break-even point, or how long it would take for the monthly savings to exceed the refinance costs and fees, to help you determine whether refinancing is likely to be worthwhile.
Related articles
Taking out a loan can be a challenging endeavor. Follow our guides to help you learn more about all the details you need to know on borrowing and lending.
Personal loans allow borrowers to finance weddings, vacations, renovations, large purchases, debt consolidation, and more. Learn more about how personal loans work.
Shopping for a mortgage is crucial to the homebuying process. Compare non-conventional vs. conventional loans, learn some key mortgage terms and more.