Refinancing a personal loan

Like mortgages, car loans and student loans, personal loans can be refinanced.  When you refinance a loan, you are essentially taking out a new loan to pay off an existing loan. That means you’re restarting the clock on your loan.

Refinancing a personal loan could be a good option if you are able to get more favorable terms on the refinanced loan than on your existing loan. A lower interest rate, for instance, could mean you could wind up paying less in interest over the term of the loan. You could qualify for a lower rate on a new loan if your credit score improves or interest rates fall. Refinancing is also a way to lower the monthly payment or to change the loan type, such as from a variable rate loan to a fixed rate loan. 

How to refinance a personal loan

There are a few ways to refinance your personal loan. The first place to check is with your current loan provider. Just note that not all loan providers allow you to refinance your loan and you may be able to get better terms with a different lender. As with any loan, you may also want to shop around to compare different lenders.

In addition to comparing the interest rate and terms, you may want to find out the minimum credit score required to qualify for the loan. Check your credit score if you haven’t done so already. You want to be selective about applying for loans because each time you do, the lender will make a hard inquiry into your credit report. Too many inquiries could cause your credit score to drop. Some lenders allow you to pre-qualify for a loan with only a soft pull on your credit - which doesn’t affect the credit score.

Once you have narrowed down your choices, submit the loan application. Once you are approved and have a new loan, make sure the old loan is paid off and the account closed. You can do this by requesting the account paperwork from the original loan provider, showing that it has been paid in full.

Even once you’ve locked in a favorable loan, it doesn’t hurt to keep an eye on rates and offers. If you know how to compare, you can always shop around. Refinancing a personal loan can be an opportunity to get lower rates or improved terms.

What you need to know before refinancing a personal loan

There are a few factors that affect whether or not it makes sense to refinance. To understand the costs of refinancing your personal loan, you’ll need to take into account any fees, the interest rate and the term of the refinanced loan, then compare those costs to your current loan. Here’s what to look for:

Refinancing sometimes comes with costs

Some personal loans come with various fees such as late fees, origination fees or prepayment penalties. These fees, if applicable, make a difference in the total cost of the loan. Say you are comparing two loans. One is a $1,000 loan with a 5.32% interest rate, 36 month term, and $40 origination fee.  Another is a 7.87% interest rate, also 36 month loan, and no origination fee.

If you just look at the interest rate, it might appear that the 5.32% interest rate loan has the advantage, but that’s not taking into account the fees. With the fee, the 5.32% interest rate becomes 8.1% APR while the other has a 7.87% APR.

Not all personal loans have these fees; different loans come with different fees and terms. Understanding the terms could help you avoid potentially costly mistakes later.

Compare the term and interest rates

A longer loan period may mean a lower monthly payment, but could also mean you’re paying more in interest over the long-term. For instance, let’s compare $10,000 personal loan with a 15% interest rate and three year term to a $10,000 personal loan with a 13% interest rate and five year term. The three year, 15% interest rate loan comes out to $346.65 a month with total interest of $2,479.52. By contrast, the five year, 13% loan comes out to $227.53 a month, but total interest adds up to $3,651.84.

When you refinance, you are taking out a new loan and potentially extending the term of your loan. If you are two years into a three-year term but want to refinance with another three year loan with a lower rate, you might end up paying more in interest.

Calculate the cost

To figure out how much you’ll save, or not, by refinancing debt, you’ll need to tally up the loan with the fees and interest over the term of the loan, then compare with the total remainder on your existing debts, including interest. There are several online loan calculators that can help you do the calculations. 

Be cautious about taking on additional debt

Personal loans are often used to consolidate debt, such as credit card debt. When refinancing a personal loan, it might be tempting to take on additional debt, especially if you’re offered an attractive rate. Just keep in mind that it is a loan that needs to be paid back with interest.

Refinancing a loan is one way to get more favorable terms, such as a lower rate, lower monthly payment or to switch from a variable rate loan to a fixed rate loan. To see whether or not it makes sense to refinance, you’ll need to calculate the costs of refinancing by taking into account any fees, the interest rate and the term of the refinanced loan, then compare those costs to your current loan.

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This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs� but may not reflect the institutional opinions of Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.