How and When to Refinance a Personal Loan

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With lingering high employment rates amid a pandemic-influenced recession, many have turned to personal loans as a life-line.

In fact, personal loan accounts are the fastest-growing debt category among Americans. 

The most common reason consumers seek personal loans is to cover emergency expenses, consolidate other debts, or make a big purchase (like a vacation or home renovation).

“Personal loans have been a good addition for lots of people that need the quick funds,” says Jill Schlesinger, a certified financial planner and host of the “Jill on Money” podcast. “The devil is in the details, though. Make sure you understand the terms, rate, fees, and overall cost.”

If you’re one of the 21 million consumers paying down an existing personal loan, what you may not know is that low interest rates have created an opportunity to find some relief through refinancing.  

“This incredibly low-interest-rate environment creates an ideal situation to look for and find a better interest rate than you already have,” says Delvin Joyce, financial planner for Prudential, a nationwide financial services firm. “Whenever you have the opportunity to move debt from a higher to lower interest, it’s always a good idea to refinance a personal loan.” 

While refinancing a personal loan can help you get out of debt faster or lower your monthly payments, it’s important to understand all the risks and benefits. 

How Personal Loan Refinancing Works

To refinance a personal loan, it works similar to refinancing a mortgage. You apply for a new loan with the intention of better rates or terms to replace your previous loan. 

“The personal loan piece is one of the most simple and easiest loans to refinance,” says David Tuyo, president and CEO of University Credit Union in Los Angeles. “It’s the least amount of paperwork. And it’s an unsecured loan, so there’s no need for liens, title work, or certain regulations around financing some sort of collateral.” 

Here is how it will look: 

  1. Get prequalified with multiple lenders and compare the rates and terms on the potential new loan. Compare this with your current loan. 
  2. Read the fine print. Not all personal loan refinance options are created equally, which is why it’s critical to look at the fine print. Check for application or origination fees that can add to the loan balance. 
  3. Pay off the current loan. If you decide the new personal loan offer is worth it, the next step is to move forward with the chosen lender to lock in your terms. Once you receive funds, use it to pay off your current loan. 
  4. Get written confirmation your previous loan is closed. 
  5. Make payments on your new personal loan based on its terms. 

When Personal Loan Refinance is a Good Idea

Income or credit has improved

Financial circumstances change over time. “Before taking the step to refinance any debt, it’s important to make sure you are creditworthy,” says Joyce.  

Your credit or income may have improved since your last loan application. This may give you the ability to refinance to a better rate or lower monthly payment. 

Get a lower interest rate

With the low-interest-rate environment we are in, average rates are falling, and you could take advantage of a new offer. This, coupled with an improved credit score or income, can position you for a better overall rate or terms.

Lower monthly payments

If you find yourself in a situation, such as unemployment, where you cannot afford your current personal loan monthly payment, refinancing can potentially lower your monthly payment by extending out your term. 

Pro Tip

Refinancing personal loans can help consolidate new debt with your current loan to save money with one single payment. Before refinancing, understand all the terms and fees involved to make sure you’re getting the best deal possible.

If you are unemployed, and in an industry that may take a while to recover, refinancing your personal loan may be a good idea just to lower your monthly payments on an existing loan you can no longer afford, says Schlesinger.  “Refinancing to a lower payment can free up cash flow for other expenses,” she adds. 

With this method, you can always pay more towards your monthly payment when you can. At least it gives you the breathing room you need in the meantime. The ability to save money on a payment puts more in your pocket, giving you more flexibility in your finances. 

Pay off the loan sooner

If you have the means, you can refinance to increase monthly payments and shorten the length of your loan. You will be debt-free sooner and also save on the interest you would have paid. “If you are in the position to shorten the term of your loan and finish the loan, it is worth considering,” says Schlesinger.  

When Personal Loan Refinance Doesn’t Make Sense

Personal loan refinance isn’t the right solution for everyone. Here are some situations where it may not make sense. 

Paying more in interest with a longer term

If you add time to your loan to lower your payments, you are adding the amount of time it takes to pay it all off. Not only will you extend your debt timeline, but also pay interest on those additional years. It’s important to understand the long-term financial consequences before making the refinance decision. 

Extra fees

Understanding the application and origination fees involved with refinancing is critical. Some loans will have these additional fees, which can add to your balance and force you to pay more interest over the life of the loan. 

“Be careful not to spin your wheels with a loan refinance,” Schlesinger warns. For example, when you add up all the fees, it may take you three years to recoup the cost of refinancing on a three and a half year loan, she explains. 

“If you’re paying $94 a month and you paid a $99 application fee, while another loan is $98 per month with no application fee, over the course of a 12-month loan, those are two very different rates of return you are paying back,” says Tuyo.

Prepayment penalties

Some lenders may charge a fee for paying off your loan early. Vet your lender and read the fine print thoroughly. Read reviews and complaints, giving you insight into their customer service approach and credibility.  

Beware of the cycle of debt

Be mindful of the perpetual debt cycle where you continually take on new loans to pay off other loans while further extending your debt timeline, says Schlesinger. 

Should You Refinance a Personal Loan?

Personal loan refinancing is always worth exploring if it puts you in a better financial position than when you started the loan, says Schlesinger. “Run the numbers. If you can get a reduction in payment or shorten the term of your loan, it’s worth considering,” Schlesinger continues.  

“Refinancing a personal loan can be a good idea if you are eligible for better terms than what you obtained when you originally applied for the loan, says Lauren Anastasio, a certified financial planner for online personal finance company SoFi.  “Refinancing your remaining balance to a lower rate can save you money on your repayment and potentially lower your monthly obligation,” she adds.

Make sure to do an apples-to-apples comparison with your current loan versus the new loan, reminds Schlesinger. Interest rates overall have decreased, and you may be able to take advantage of that. Be aware, though, that you may not get the low rate you see online based on your credit, she says. 

Consider all your options other than personal loan refinance, too, Schlesinger tells us. If you own a home, refinancing your mortgage is also an option. “Ask yourself, what is the most efficient debt to get rid of to get me through a period of time?” 

Experts agree that refinancing a personal loan can be an easy solution to roll multiple payments into one easy-to-pay bill every month. But the experts advise to thoroughly investigate all the pros and cons of rolling over any debt into a new loan product and make sure you are well informed on the new loan’s terms before making any decision. Sometimes it won’t make fiscal sense to extend your debt-horizon and pay interest during that time.