If, When, and How to Refinance a Personal Loan

Paying too much interest on your debt consolidation loan? Need to reduce the monthly payment on your home improvement loan? Looking to shorten the payoff period for your vacation loan?

If you answered yes to any or all of these questions, it may be time to refinance your personal loan. Here’s your guide to determining if, when, and how to replace your current loan with a new one.

Can You Refinance a Personal Loan?

Yes, you can refinance a personal loan. In fact, if you find a new loan that allows you to lower your interest rate, reduce your monthly payments, or shorten your repayment period, you probably should refinance.

When you refinance a personal loan, you take out a new loan — either with your current lender or another financial institution — and use the funds to pay off your old loan. Then, you begin making payments on your new loan as outlined in your personal loan agreement.

How a Personal Loan Refinance Works

Regardless of the reason you want or need to refinance, you’ll repeat many of the same steps you took when applying for your original loan. Here’s what to expect:  

Checking Your Credit

Your credit score goes a long way toward determining if you’ll qualify for a new loan and the interest rate you’ll receive. Generally, lenders look for a credit score of 660 or above when refinancing, though you might be approved for a higher-interest loan if your score is below 660.

Getting Prequalified

Prequalification helps you better understand how much money you can borrow and what interest rate you’ll likely get if you refinance. It costs nothing, doesn’t affect your credit score, and allows you to do apples-to-apples comparisons of loan terms, interest rates, and fees.

Choosing a Lender

When choosing a lender, you’ll have to decide whether to borrow from your credit union or bank or apply for an online loan. Either way, your goal should be to find a refinancer you feel comfortable with and who offers the best rates and terms for your financial situation.

Submitting Your Application

Once you choose a refinance company, you’ll need to pull together documents and other information required for your application. This usually includes:

• Proof of identity like a driver's license or passport
• Proof of income such as bank statements, pay stubs, and tax returns
• Proof of address like a voter registration card, utility bill, or rental agreement

After completing and submitting your application, you’ll wait anywhere from a few minutes to several days to find out if you’re approved. If you’re green-lighted, you should receive the loan funds within seven days or less, depending on the lender and other factors.

Closing Your Old Loan

The main difference between taking out an original loan and refinancing a loan is the process of paying off and closing your old account, which you will do after you get money from your new loan. Depending on the terms of your original loan, you may be charged a prepayment penalty.

Starting Your New Loan

The repayment period on your personal loan refinance officially begins once the money goes into your account. So, from that moment forward, you’ll start and continue making set monthly payments as outlined in the loan agreement until the debt is paid off.

When Should You Refinance a Personal Loan?

Although you can technically refinance your personal loan whenever you find a willing lender, that doesn’t mean you should. Refinancing makes the most sense when:

Your Credit Has Improved

There’s a simple, undeniable fact about personal loans: The better your credit, the better your options. A credit score of Good (670-739), Very Good (740-799), or Excellent (800-850) can open a world of lower-interest opportunities.

If you’ve consistently made your loan payments on time and your credit score has improved, you may qualify for a better interest rate on a new loan. In this case, refinancing could save you a lot of money.

You Need to Lower Your Payments

Life is full of surprises, some of which can affect your monthly cash flow. If your financial situation has changed since you took out your original loan, refinancing may allow you to rework your personal budget.

Replacing your old loan with a new one and extending your repayment term can lower your monthly payments, leaving you money to pay other expenses or build your savings. Just remember that taking longer to repay your loan means you’ll likely pay more interest over time.

You Want to Pay Off Your Loan Faster

On the other hand, if you can afford to pay a bit more each month without busting your budget, refinancing to a shorter-term loan can reduce your total interest costs and help you settle the debt sooner.

Before deciding that refinancing is the route for you, you’ll need to determine if the long-term savings you’ll enjoy will offset any penalties or fees you may face for paying off your original loan early or taking out a new loan.

Pros and Cons of Refinancing a Personal Loan

Pros

There are a number of potential benefits to refinancing your current personal loan. They include: 

Interest Rate Adjustments

Depending on your credit, the lender, and market conditions, you might be able to secure a better interest rate on a personal loan refinance than you have on your current loan.

Loan Term Flexibility

Refinancing allows you to extend or shorten the repayment period of your loan, which decreases or increases your monthly payments and the amount of interest you ultimately pay.

Payment Stability

If you switch from a variable rate to a fixed-rate loan, you can lock in your monthly payments and plan your personal budget more accurately.

Cons

Of course, refinancing isn’t without its trade-offs. Before you replace your old loan with a new one, you’ll need to consider:

Penalties and Fees

Taking out a new loan may trigger penalties and fees — like an origination fee or a prepayment penalty — that could reduce any savings you’d otherwise enjoy.  

Qualification Requirements

Since most personal loans are unsecured, it may be difficult to find one with better terms if you’re struggling financially or your credit score has dipped.

Cycle of Debt

If you continually take out new loans to pay other loans and extend your repayment timeline to lower your monthly bills, you run the risk of falling into a debt cycle that’s difficult to escape.

The Takeaway

If the situation and timing are right, refinancing your personal loan can be an effective way to save money, improve cash flow, or get out of debt more quickly.  

But it isn’t for everyone.

Do your research, weigh your options, and take an honest look at your finances to determine if replacing one loan with another makes sense for your situation.