When And How To Refinance A Personal Loan? Detailed Answers

Many consumers find themselves in need of some extra money for life’s unexpected bills. These situations include unexpected repairs and remodeling, a special event, or a consolidation of high interest credit cards. Many consumers have used unsecured personal loans to pay for these expenses and spread the debt out over a few years.

If you did not get a favorable interest rate with that initial personal loans, lenders offer refinancing offers. It is possible to lower the interest rate, spread out payments in a different way, or even take out more money – whatever meets your financial needs. 

In this article, we will explain how, why, and when to pursues a personal loan refinance.

What Is A Personal Loan?

Personal loans are installment loan products where consumers borrow money from a bank, credit union, or other lender and repay in equal installments over time. Typical personal loans range from 1 to 7 years in length. As the name suggests, the uses of the money are more flexible than other common loan products. Borrowers often use the money to pay for sudden expenses, home improvements, special events, or paying off high interest credit cards. 

Unlike mortgages or auto loans, personal loans are usually completely unsecured or secured by various personal property. This means that there is sully no collateral to be repossessed by the lender in the case of default. This leaves the lender more exposed to risk. Thus, personal loans tend to have higher interest rates than secured loans – especially for moderate to low credit borrowers. But they do usually have lower rates than high interest credit cards. When you receive a personal loan, you will get a lump sum of the money. Then equal installment payments will be repaid until the loan balance is completed.

What Does Refinancing Mean?

Refinianunc occurs when a borrower replaces an existing loan with a new loan with different terms and conditions that are still attached to the same debt or asset. Typical inducements include lower interest rates, changing the length of the term, changing the payment amount, or cashing out equity. 

Types of loans that can be refinanced include home mortgages, car loans, and personal loans. Borrowers typically go through an application process that may be slightly less detailed than the original purchase. The lender then decides if they are a worthwhile credit risk. If so, a new loan is offered. Part of the refinancing process includes paying off the existing loan and the new loan replaces it.

Pros & Cons Of Refinancing A Personal Loan

Refinancing a loan can have financial benefits and save money,  but  also carry some risks. The most common benefit is lower interest rates. When the federal changes their reserve requirements, it often leads to more money available for loans and thus lower interest rates on all types of financial products. Consumers can often refinance at a lower rate. This also can occur if the borrower has improved their credit score and qualifies for a better rate. 

Refinancing can result in lower monthly payments, giving borrowers better balance sheets each month. Borrowers can gain a shorter or longer loan term. Which can be beneficial, depending on the borrower’s goals. A shorter term will help pay off the loan and save overall financing charges, while a longer term usually results in lower payments. Additionally, borrowers can tap into equity and get cash back on a new loan. 

However, there are also downsides to refinancing. First, refinancing can come with fees that will end up canceling out some of the savings. Frequent refinancing can impact credit scores if the borrower ends up with many hard inquiries. And most risky, the borrower who taps into equity may end up defaulting in the new loan and putting collateral at risk.

When Should You Refinance Personal Loans?

There are several situations that make refinancing a personal loan a viable option. The first situation is when interest rates go down. When personal loan products across the market dip in interest rates, it becomes likely that the borrower can now qualify for new loans with lower financing charges. Similarly, borrowers who have improved their credit score should shop around to see if they can find a lower interest rate. 

Since personal loans are typically not secured by significant assets like a mortgage or car loan – their rates are often high for borrowers with moderate or poor credit. When one improves their credit, they can see significant savings on the financing rate.  In either of these cases, it only makes sense to go through the process if the borrower will see a significantly lower interest rate. A slightly lower rate will likely be offset by loan fees and result in no net savings.

How To Refinance A Personal Loan

If you have an outstanding personal loan, you may be shopping around looking for a refinancing opportunity – but perhaps you are wondering where to start. The first step is to apply for pre-approval with several reputable lenders – including your current lender who may be able to provide a streamlined process.

Then you will provide details about your loan and your finances to the lenders. If you receive an offer, you will also have to provide payoff information for the existing loan. Check on and avoid origination fees and other fees as much as possible. These fees can negate any advantage gained in interest rates.

How Can You Use Personal Loan Funds?

Personal loans are a form of unsecured loan. Thus, they may be used for a wide variety of personal purposes. One common use of personal loans is for unexpected expenses. This may be the case when one needs a costly auto repair, new appliances to replace ones that are broken down or other similar important and urgent bills.

Another use for personal loan funds is for special events. They can be used to pay for a wedding or a once in a lifetime vacation. Others use the funds differently by putting them toward debt consolidation. Some consumers  who hold multiple high interest revolving credit cards may be able to use a lower interest personal loan to pay off those debts and consolidate it into one lower monthly payment. You may wonder if there is anything that personal loan funds cannot be used for. 

Some lenders do not require any explanation of the use of funds, while others only permit certain uses.  For example, personal loan funds may be prohibited from use for gambling, paying for college, or to pay for a mortgage down payment. However, use for personal reasons is generally widely acceptable.         

Does Personal Loan Refinancing Affect Your Credit Score?

When considering personal loan refinancing, it is essential to understand how it will affect your credit report. While it is true that any loan will have an impact on your credit, the magnitude and duration of that impact will depend on several variables.

The first impact that you will experience is that hard inquiries from personal loan lenders will appear on your credit reports as you apply for the loan. Inquiries will generally reduce your score a bit, but the impact is small and temporary. The rest of the impact is more complicated and depends on factors such as the loan amount, the use of the funds, and your payment history. For example, if you use a personal loan to consolidate debt, it can be used to pay off credit cards, reducing your loan balance to credit limit ratio, which can make a significant improvement to your credit score.

On the other hand, if you use the loan to make a large purchase or to fund a vacation, it can increase your credit utilization ratio, which may lower your credit score. Your payment history is also an important factor in determining the impact of personal loan refinancing on your credit score. Timely payments on your new loan can help build your credit and increase your score.

However, missed payments or defaults will have a negative impact on your score and could affect your ability to obtain credit in the future.

Conclusion

Personal loans are varied and flexible loan products which help millions of people with unexpected expenses or special events. Since the field is filled with eager lenders, there are always opportunities to refinance and get a new personal loan. Thus, consumers shoul d always be alert when interest rates have fallen or if their own credit history improves significantly. 

In those cases, they are likely to find a refinance opportunity that makes a noticeable difference in payment amount, total interest paid, or other important terms of the loan.

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