How and when to refinance a personal loan

With employment rates persistently high amid a pandemic-affected recession, many personal loans have turned as the lifeline.

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

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

“For many people who need quick money, personal loans are a good addition,” says Jill Schlesinger, certified financial planner and host of the “Jill on Money” podcast. “The devil is in the details. Make sure you understand the terms, price, fees, and total cost. “

If you are among the 21 million consumers who are paying off an existing personal loan, you may not know that the low interest rates created an opportunity to find some relief through refinancing.

“This incredibly low interest rate environment creates an ideal situation for searching and finding a better interest rate than you already have,” said Delvin Joyce, financial planner at Prudential, a nationwide financial services company. “When you have the option to move debt from higher to lower interest rates, it is always a good idea to refinance a personal loan.”

While personal loan refinancing can help you get off debt faster or lower your monthly payments, understanding all of the risks and benefits is important.

What does it mean to refinance a personal loan?

Refinancing a personal loan works similarly to refinancing a mortgage. You are applying for a new loan with the intention of getting better interest rates or terms to replace your previous loan.

“The personal loan is one of the easiest and easiest to refinance loans,” said David Tuyo, President and CEO of the University Credit Union in Los Angeles. “This is the least amount of paperwork. And it’s an unsecured loan, so no liens, title work, or specific collateral funding regulations are required. ”

How to refinance a personal loan

When you’re ready to refinance your loan, it looks like this:

  1. Get prequalified with multiple lenders and compare the interest rates and terms of the potential new loan. Compare this to your current credit.
  2. Read the fine print. Not all personal loan refinancing options are created alike, which is why it is important to pay attention to the fine print. Check to see if there are any application or issuance fees that could add to the loan balance.
  3. Pay off the current loan. If you decide that the new personal loan offer is worth it, the next step is to proceed with the selected lender to set your terms. Once you have received the money, you can use it to pay off your current loan.
  4. Get a written confirmation Your previous loan is closed.
  5. Pay bills on your new personal loan according to its terms.

When personal loan refinancing is a good idea

Income or credit has improved

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

Your creditworthiness or income may have improved since your last loan application. This can give you the opportunity to refinance yourself at a better interest rate or a lower monthly payment.

Get a lower interest rate

In the low interest rate environment, the average interest rate falls and you could benefit from a new offer. This, coupled with improved creditworthiness or income, can position you for better overall price or terms.

Lower monthly payments

If you find yourself in a situation where you cannot afford the monthly payment of your current personal loan due to unemployment, for example, a refinance can potentially lower your monthly payment by extending the term.

Pro tip

Personal loan refinancing can help consolidate new debt with your current loan to save money with a single payment. Before refinancing, familiarize yourself with all of the terms and fees to ensure you get the best deal possible.

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

This method allows you to add more to your monthly payment at any time. After all, it will give you the freedom you need in the meantime. The ability to save money on one payment puts more in your pocket and gives you more flexibility in your finances.

Pay off the loan earlier

If you have the funds, you can increase the monthly payments and shorten the life of your loan. You’ll be debt free sooner and also save the interest you would have paid. “If you are able to shorten the life of your loan and terminate the loan, it is worth considering,” says Schlesinger.

When refinancing personal loans doesn’t make sense

Refinancing personal loan is not the right solution for everyone. Here are some situations where it might not make sense.

Pay more interest with a longer term

As you add time to your loan to lower your payments, you increase the time it takes to pay everything off. Not only do you extend your debt term, but you also pay interest for those additional years. It is important to understand the long-term financial consequences before making the refinancing decision.

extra cost

Understanding the application and origination fees associated with refinancing is crucial. Some loans have these additional fees that can add to your balance and force you to pay more interest over the life of the loan.

“Be careful that you don’t go nuts with a loan refinancing,” warns Schlesinger. For example, if you add up all of the fees, it can take you three years to amortize the refinancing cost of a three and a half year loan, she explains.

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

Prepayment penalties

Some lenders may charge an early repayment fee on your loan. Check your lender and read the fine print carefully. Read reviews and complaints that will give you some insight into their customer service and credibility.

Beware of the debt cycle

Think about the perpetual debt cycle in which you keep taking out new loans to pay off other loans while continuing to extend your debt term, says Schlesinger.

Should You Refinance A Personal Loan?

Refinancing personal loans is always worth checking if you are financially better off than at the beginning of the loan, says Schlesinger. “Let the numbers run. It is worth considering whether a shortening or a shortening of the credit period is possible, ”Schlesinger continued.

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

Make sure you do an apple-to-apple comparison between your current loan and the new loan, recalls Schlesinger. Overall interest rates are down and you can take advantage of them. Be aware, however, that your credit balances may not get you the low price you see online, she says.

Also, consider all of your options except refinancing personal loans, says Schlesinger. If you own a home, you can also refinance your mortgage. “Are you wondering what is the most efficient guilt you can get rid of to get me through a certain amount of time?”

Experts agree that refinancing a personal loan can be a simple solution to bundling multiple payments each month onto one easy-to-pay bill. However, the experts advise you to thoroughly study all the pros and cons of transferring debt to a new loan product and make sure you are well educated about the terms of the new loan before making a decision. Sometimes it doesn’t make sense for tax purposes to extend the debt horizon and pay interest during this time.