Refinancing a personal loan involves taking out a new loan and using that money to pay off an existing loan. You can refinance a personal loan at any time, but it is most beneficial for borrowers who have improved their credit scores since applying for their original loans and will qualify for a lower interest rate.
Personal loan refinancing may also be a good option for people who want to reduce their monthly payments by extending the loan term. Keep in mind that refinancing often comes with underwriting fees and may result in a dip in your credit score, which could occur when a lender conducts a hard credit check as part of the underwriting process. You may also be subject to a prepayment penalty fee from the original lender.
When Is the Best Time to Refinance a Personal Loan?
Absent restrictions in their loan agreements, borrowers usually can refinance a personal loan as soon as they start making payments. However, there are certain circumstances where refinancing a loan makes more sense and is more beneficial to the borrower. Consider refinancing your personal loan if you:
- Have access to a lower interest rate based on a higher credit score or more favorable lending environment
- Want to decrease your payments
- Are facing a balloon payment that you are unable—or unwilling—to pay
- Are comfortable with potentially lowering your credit score as a result of the application process
- Don’t have access to a balance transfer credit card or other source of funds
How To Refinance a Personal Loan in 5 Steps
The loan refinancing process varies by lender. However, it is largely similar to the standard loan application process. Follow these steps to refinance your personal loan:
1. Check Your Credit Score
When refinancing a personal loan, start by checking your credit score. Check with your bank or credit card company, as they may let you check your score for free. In general, lenders look for a credit score of 660 when refinancing personal loans, but a score between 580 and 600 may be sufficient. However, a higher score will give you access to more favorable terms—like lower interest rates.
If possible, familiarize yourself with your credit score and history prior to the refinancing application process. This way, you’ll have time to make improvements—like reducing your credit utilization rate—before a lender does a hard credit check.
2. Shop for Terms
When your credit score is in good shape, research traditional and online lenders that offer personal loan refinancing. Start by contacting your current loan provider to see if it is willing to refinance your loan. Your current lender also should be able to tell you the amount outstanding on your loan so you know what to borrow. Next, contact local banks and online lenders to compare interest rates and other loan terms.
When shopping for a lender, compare loan terms and interest rates, which generally range from about 3.5% up to 35% or higher. You should also evaluate each lender’s origination fees to ensure they don’t exceed the standard 0.5% to 1% of the total loan amount.
3. Apply for the Loan and Await Underwriting
Once you choose a lender, compile all of the information and documentation the bank needs to complete your application. This likely will include copies of your most recent tax returns and pay stubs, but the precise application requirements will vary by lender. Following completion of your loan application, expect to wait a few hours to a few weeks to get approval.
4. Pay Off the Original Loan
After the new loan proceeds have been dispersed, use them to pay off the balance of your original loan. Depending on the terms of your original loan, you also may be responsible for a prepayment penalty. Finally, await confirmation from the lender that your account has been closed so you can avoid any further fees and penalties.
5. Start Making Payments on the New Loan
Following disbursement and repayment of your original loan, begin making regular payments on the new loan. If possible, sign up for automatic payments so you don’t have to remember to pay each month. Regular, on-time payments will help restore any damage done to your credit score during the application process and can help you build your credit history in the long term.
Use a Personal Loan Calculator to Determine Savings
It can be difficult to determine whether loan refinancing is your best option. However, a personal loan calculator can make it easier to estimate your monthly and overall payments so you know what to expect. Loan calculators also make it easier to compare multiple loans when shopping for the most favorable terms.
How a Personal Loan Refinance Impacts Your Credit Score
Refinancing a personal loan can impact your credit score in several ways: First, refinancing a loan typically requires a hard credit check, which can negatively impact your score. However, this is usually a minor dip and is often outweighed by the benefits of refinancing. Just make sure to shop for loans within a limited period of time—usually between 14 and 45 days—so credit bureaus will only treat the applications as a single one for reporting purposes.
Your credit score may also decline when your original loan account is closed as a result of the refi. However, the impact of closing this account will depend largely on when the original loan was issued in relation to your other outstanding debts and whether it was in good standing. Most of the time, borrowers can regain their original credit standing simply by making on-time payments on the new loan.
Advantages of Refinancing a Personal Loan
- Lower interest rates may be available based on your credit score and the current lending climate
- Depending on available terms, you can choose a longer or shorter payoff period
- Extending the loan period means lower monthly payments
- You may be able to switch from a variable- to a fixed-rate loan
Disadvantages of Refinancing a Personal Loan
- Lenders typically charge origination fees between 0.5% and 1% of the loan amount
- You may have to pay prepayment penalties on your original loan
- Most lenders require a hard credit inquiry, which can negatively impact your credit score
- By extending your loan term, you will have to pay more interest over time
Alternatives to Refinancing a Personal Loan
There are really just three alternatives to refinancing a personal loan: The first alternative is to pay off the loan balance and close the account. However, this is generally not an option and some borrowers resort to a second, less appealing alternative—defaulting on the loan.
Fortunately, some borrowers also have access to balance transfer credit cards that let them transfer the outstanding loan balance and pay it over time. Borrowers with a good to excellent credit score may be able to access a 0% interest rate for an introductory period of 12 months or more. This makes it an excellent alternative for borrowers with a strong credit history. Keep in mind, however, that many cards charge a fee between 3% and 5% of the transferred balance.