When and How to Refinance a Personal Loan
Quick Answer
Refinancing a personal loan is similar to applying for a new loan, but you use the loan proceeds to pay off your existing debt. Consider refinancing your personal loan when you can qualify for a lower interest rate or need to adjust your payment timeline.
Refinancing a personal loan may be a smart move if it saves you money or lowers your monthly payments. But there are drawbacks too. Refinancing can temporarily lower your credit score, and savings aren't guaranteed. Plus, the fees sometimes outweigh the benefits.
Below, learn more about how to refinance a personal loan, when it makes sense and what you should consider before doing so.
What Does It Mean to Refinance a Personal Loan?
Refinancing a personal loan involves taking out a new personal loan to pay off an existing one, usually with the intent of securing better loan terms.
For example, if your credit score has improved since taking out your initial loan, refinancing may help you qualify for a lower-interest loan and save money in the long run. Alternatively, if you're struggling to repay your loan, you might refinance with a longer term. This could lower your monthly payments to a more manageable amount.
How to Refinance a Personal Loan
Refinancing a personal loan is similar to applying for an initial loan—but with a few additional steps.
1. Check Your Credit Score
Your credit score can impact your ability to refinance your loan at a favorable rate, so you should check it before getting started. You can check your credit scores for free with Experian anytime. Generally, you can also check your credit score for free on your banking or credit card app. Most lenders share this information on your monthly statement or in your online account. Also be sure to review your credit report for free with Experian or at AnnualCreditReport.com to make sure there are no errors negatively affecting your score.
2. Shop Around for Lenders
Once you're familiar with your credit score, compare loan rates by prequalifying with several lenders. Prequalifying for a loan provides a rate estimate without a hard credit pull, but it's not a rate guarantee.
When comparing lenders, consider rates, fees, potential discounts and customer satisfaction. You should also compare these factors with your existing loan to help you decide whether refinancing is worth it.
Tip: Use a personal loan calculator to estimate your new monthly payment based on different interest rates and term lengths. This can help you see how potential loans fit into your budget before you decide whether or not to refinance.
3. Apply for the Loan
After choosing a lender, complete the formal loan application and submit any required documentation. Lenders often ask for pay stubs, tax returns, proof of address, your Social Security number and more. They'll use this information to evaluate your income, debt-to-income ratio (DTI) and payment history. Many lenders offer online applications.
4. Get Approved and Review Terms
If the lender approves your application, you'll receive a loan offer to review. Ask about anything that's unclear to you, and make sure you understand fees, interest and your loan term. If everything looks good, sign the loan offer and return it to the lender.
5. Use Funds to Pay Off Your Existing Loan
Finally, you'll receive your loan funds. Depending on the lender, this can be as soon as the same day you sign your loan agreement. Some lenders deposit loan proceeds directly into your bank account, while others make a direct payment to your existing lender. If your new lender deposits the loan proceeds into your account, make sure you pay off your existing loan and confirm account closure.
6. Begin Repaying the New Loan
After paying off your existing loan, you'll need to start making payments to your new lender. Enroll in autopay or keep close track of payment due dates so you don't fall behind. Missed or late payments can result in fees and a drop in your credit score, which could make borrowing more difficult in the future.
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Pros and Cons of Refinancing a Personal Loan
Refinancing a personal loan can have several advantages, but there may be downsides too. Before refinancing, weigh the following factors.
Pros
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Lower interest rates: Refinancing can be a good opportunity to lower your interest rate and save money long term. If your credit has improved since you last applied for a loan, you may be able to qualify for a lower interest rate.
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Debt consolidation: If you have multiple outstanding debts, refinancing allows you to consolidate these accounts into a single monthly payment. Not only can debt consolidation simplify your money management, but it can also save you money if your new loan has a rate lower than the average of your existing rates.
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Lower monthly payment: If your monthly cash flow is tight, you can refinance your personal loan and choose a longer repayment period. This leads to smaller, more manageable monthly payments.
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Faster repayment: If your income increases or you otherwise have more wiggle room in your budget, you can refinance to pay off your loan faster. This may increase your monthly payment amount, but you'll save money on interest, lowering your overall cost of borrowing.
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Higher borrowing limit: If you need to borrow more money, you may be able to refinance with a larger loan. This means you could pay off your existing loan and use the remaining funds for another purpose.
Cons
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Fees: Some lenders charge origination fees for new loans. This administrative fee, which is typically 1% to 8% of the loan amount, is deducted from your loan proceeds. If your lender charges an origination fee, weigh the cost against any monetary savings you're expecting to get with your new loan.
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Longer repayment: If you refinance with the goal of lowering your monthly payment, you may need to choose a longer repayment period to do so. This will extend your debt payoff timeline, lengthening your financial commitment.
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Temporary credit dip: Applying for a loan (and paying one off) temporarily lowers your credit score by a few points. Consider this downside if you're planning on applying for more credit in the near future.
Should I Refinance a Personal Loan?
Refinancing a personal loan makes sense in some circumstances, but it's not always worth it. The following scenarios can help you decide when to refinance a personal loan—and when you should reconsider.
When to Refinance a Personal Loan
- Your credit score has improved. A higher credit score means you're more likely to qualify for a lender's lowest rates. If your score has increased since you took out your original loan, refinancing could result in a lower interest rate and significant savings.
- You need lower monthly payments. If your income isn't enough to cover your expenses, you may benefit from a lower monthly loan payment. Refinancing can lower your monthly payments by spreading them over a longer loan term.
- You want to pay off your loan faster. There are several reasons you may want to pay off your loan faster, whether you have competing financial priorities or you simply want to become debt-free. By lowering your interest rate or choosing a shorter repayment period, refinancing can help you speed up your debt payoff.
When to Avoid Refinancing a Personal Loan
- You're close to paying off your loan. If you're only months away from paying off your loan, refinancing may not be worth the expense and administrative hassle.
- Your interest rate would increase. Whether your credit score has dropped or interest rates have risen, you may want to avoid refinancing if your interest rate would increase. Higher rates mean a bigger overall cost and, potentially, larger monthly payments.
- You'll pay high fees. Some lenders charge high origination or other personal loan fees that cut into your loan proceeds. You may not want to refinance if these fees outweigh potential savings.
Frequently Asked Questions
The Bottom Line
Refinancing a personal loan can help you save money and get out of debt sooner. But it also has potential downsides—such as fees and a temporary dip in your credit score.
Refinancing a personal loan can be advantageous if you qualify for a lower interest rate or need to adjust your monthly payments to better fit your budget. But if you have to pay hefty fees, can't qualify for a lower rate or are close to paying off your loan, refinancing may not be worth it.
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About the author
Emily Batdorf
Emily Batdorf is a finance writer based in northern Michigan. She specializes in topics including budgeting, banking and debt payoff, leveraging her education background to break complex topics into approachable content.
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