Taking out a personal loan to consolidate your debt or pay for a major expense can go a long way toward helping with your finances and getting you debt-free. However, once you’ve taken out a personal loan and you’re making the required payments on time, you may start to wonder about refinancing the loan. Is refinancing your personal loan to get a lower interest rate possible? And is it worth it?
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Yes, refinancing personal loans is not only possible, it can also be a good idea. It makes sense if your credit score has improved to a level where you’ll be offered enough of a rate reduction to compensate for any loan origination fees and costs associated with the loan.
When to refinance loans
- Debt consolidation: Typically, personal loan rates are lower than credit card rates, so this could save you thousands of dollars in interest.
- Home improvement: Consider refinancing your personal loan when you want to do a home repair, remodel your home, get new appliances like a washer and dryer, put in a pool or furnish your home.
- Major expense: Consider refinancing for things like a medical procedure, funeral, adoption, wedding or other big expense.
How to refinance loans
1. Figure out how much money you need.
The amount you need will determine your loan payments, of course. A smaller personal loan is always ideal, but if you need a larger sum, make sure you can comfortably make the monthly payments.
2. Check your credit score and report so you know whether your credit is good enough for a low rate.
Before you consider refinancing your loan, you’ll need to know whether you qualify for a lower rate than what you’re currently paying. If the new interest rate isn’t significantly lower, it may not be worth it to refinance.
3. Shop for rates and terms at banks and online lenders.
Research is key when you need to refinance personal loans. It’s worth it to see what different banks and online lenders offer and what their requirements are. A newer loan with a lower interest rate isn’t necessarily better if you’re paying it off for a longer time. One issue with refinancing is the temptation to extend the maturity of the new loan out past the maturity of the current loan. Then, even if you get a lower interest rate, you can end up paying more in total interest expenses. Pull out a calculator and do the math for any rate offered. What will your final payment be?
4. Ask the lender whether inquiring about the loan’s interest rate will affect your credit score.
Peer-to-peer lenders will let you shop for rates on a loan without it affecting your credit score until you actually close on the new loan. Once you do close on a new loan, however, your credit score can take a small hit. The dip in your credit score is often temporary, though.
5. Contact the lender once you choose one with favorable rates and requirements.
If you like the choices your lender offers, contact them to discuss the rates further. There’s a lot of fine print, and you want to make sure your lender guides you through it all. Before making a final decision, have them provide the pros and cons of each rate.
6. Compare refinance rates
Finally, compare the refinance rates and take notes for every rate presented. Make a quick chart to compare key features and interest rates. Then, based on your chart, your research and your discussions with the lender, decide what’s best for you.
How refinancing a loan affects your credit score
When you refinance, you’ll have to go through a new credit check again. This can lower your credit score slightly. However, if you qualify for a lower interest rate, it does mean you get to pay off the loan faster. So, a small, temporary hit to your credit score may not matter in the long run.
On the other hand, a small hit could hurt you if it’s at a time when you’re moving and need to rent or buy a place. Landlords do check your credit score and refinancing your loan at the wrong time could make it difficult to find housing. Also, if you need to buy a new car, you’ll need a good credit score if you plan on making monthly car payments.
Pros and Cons of Refinancing a Loan
Refinance Loan Pros:
- Save money
- Lower payments
- Better interest rates
- Shorten length of loan
- More options
- Consolidate debts
- Change loan type
Refinance Loan Cons:
- Transaction costs and fees
- Higher interest if period extends
- Stricter qualifications
- Lost benefits of previous loan
- Pay more in total interest expenses
- Possible prepayment penalty
Does refinancing make sense?
You can use Bankrate’s mortgage refinancing calculator to see if it makes sense to refinance your personal loan. Just input the tax rate as 0%, list points paid as zero, and check the box to not include any private mortgage insurance, or PMI. Input any closing costs such as a loan origination fee into the line “other closing costs.” It’s not pretty, but you can make it work.
If you’re looking to refinance personal loans, it’s important to do thorough research. Find out when to refinance your loan, if you’ll get a lower interest rate, how to do so and what the pros and cons are. Once you’ve schooled yourself on the details and talked to lenders, you can see the big picture and determine whether refinancing makes sense.