When and How To Refinance a Personal Loan (2024 Guide)

Refinancing a loan simply means getting a new loan and using those funds to pay off your existing debt. Once your new loan has closed and you’ve paid off the balance on the original balance, you’ll start making payments on the new loan.

There are a few reasons to consider refinancing a personal loan, but many borrowers refinance to obtain more favorable terms than those of the original loan. For example, if interest rates have dropped since you got your personal loan, you could refinance to get a lower rate. Similarly, you could also refinance to shorten the term (if you can now afford higher payments) or lengthen the term (if you need your monthly payments to be lower).

You may be able to refinance your loan either through your current lender or a different one. It’s best to compare refinancing offers from several different lenders to find the best deal.

Before you decide to refinance a personal loan, it’s important to understand the potential benefits and drawbacks.

Refinancing isn’t always the best option, but there are certain circumstances when it may be beneficial. Here are some situations when you may want to consider refinancing a personal loan.

Drop in Interest Rates

When interest rates drop, it’s a good time to consider refinancing an existing loan. The interest rate that you pay on a loan is based on market conditions. For a fixed-rate loan, your rate is based on whatever the index was when the lender originated your loan. If the market has caused rates to drop since then, refinancing could allow you to lower your monthly payments and pay less in interest. 

Refinancing may be beneficial even if your current loan has a variable interest rate. Although the payments on your current loan have likely dropped as interest rates have fallen, refinancing to a fixed rate can allow you to lock in a low interest rate that will typically remain the same for the life of the loan. Doing so can protect you from potentially having higher payments if interest rates rise in the future.

Improved Credit Score

Another reason to consider refinancing a personal loan is if your credit score has improved since you obtained the original loan. Your credit score can have a significant impact on the terms of your loan; a lower credit score generally means higher interest rates.

However, you can improve your credit score over time by paying your bills on time, reducing your overall debt usage and not applying for several new credit accounts in a short period. Once you’ve improved your credit score, you may be eligible to refinance and get a loan with better terms, which could save you money on interest or shorten the repayment time.

Change in Your Financial Situation

If your financial situation has changed since you got your personal loan, you may want to consider refinancing. For example, if you have more income now than when you initially got your loan, you may be able to afford higher monthly payments. You could consider refinancing to a loan with a shorter term, allowing you to become debt-free more quickly and pay less in interest overall.

However, it may also be worth refinancing if your financial situation has become more challenging over the course of the loan. If you are worried you may not be able to continue making your loan payments, you may be able to refinance to a loan with a longer term. Doing so could lower your monthly payment amount, making the loan easier to fit into a tighter budget.

While there are several circumstances where it may be advantageous to refinance a personal loan, there are also times when refinancing could have a negative impact. For example, if your current loan has a prepayment penalty, refinancing might not save you much money in the long run.

You might also be better off waiting on refinancing if you’ve only had your personal loan for a short time. Most personal loans are amortized, which means that part of each payment goes toward the principal balance and the rest goes toward interest. 

When you’re early in the loan term, a bigger percentage of your monthly payment goes toward interest instead of the principal. If you refinance early, your loan balance will probably be fairly close to the original amount, and you’ll have to “start over” making payments that mostly go toward interest.

Refinancing also might not be beneficial if your credit score has worsened since you obtained the original loan. You may not be able to qualify for a loan with better terms. Instead, you could end up with a higher interest rate, which may lead to higher monthly payments and more interest paid over time.

If you feel like refinancing is the best option for you, you can follow these steps to refinance your personal loan.

Evaluate Your Current Loan Terms

Before you start looking for a new loan, it’s important to make sure you have a thorough understanding of your existing personal loan and credit history. Verify the interest rate, the terms of the loan, the principal balance and how much longer you have before it’s paid off. Don’t forget to check with your lender about any prepayment penalties or fees that could take effect if you refinance.

Research and Compare Lenders

Spend a little time researching lenders to get a good idea of the loan terms you may qualify for. Now is a good time to check your credit score to see what range it’s in — the better your credit is, the more likely you are to get a favorable interest rate.

Shop around with different lenders to see what rates and repayment terms they’re offering. It’s a good idea to verify borrowing limits to make sure you choose a lender that will offer enough to cover your existing loan. Make sure to also review each lender’s origination fees — you may need to be prepared to pay the fee or increase the new loan amount to cover it.

Check Eligibility and Gather Documentation

Before you officially apply for a loan, it’s generally a good idea to go through the prequalification process. Applying for a loan requires time-consuming paperwork and initiates a hard credit inquiry, so it may be best to save that step for last, once you know exactly which lender you want to work with and the terms of the loan you want to apply for. 

The prequalification process is fairly simple, and it gives you an idea of the terms of your potential loan. Once you know the approximate interest rate, loan amount and repayment term you qualify for, you can compare offers from lenders and decide which one to pursue. During the prequalification process, most lenders will make a soft credit inquiry, which doesn’t impact your score like a hard inquiry.

This is also a good time to gather all the loan application documentation. Most lenders require a government-issued ID and bank statements, and you may have to show proof of residence as well. You may also need to provide copies of your tax returns and pay stubs.

Apply to the Best Offer

Once you’ve decided which lender’s offer aligns the most with your refinancing goals, you can submit a formal application. If you thoroughly researched various lenders and are prequalified, you may only need to submit a loan application to one lender — the one with the best deal. However, it’s always good to have a backup plan in case the loan offer you receive isn’t what you expected. 

When you’re deciding how much to apply for, remember to account for any origination fees or prepayment penalties. If you don’t want to pay these charges out of your own pocket, you may need to increase the total amount of your refinancing loan to cover them.

Review the Offer

After you’ve completed the formal application process, you’ll get your official loan offer. As you evaluate your offer, make sure you understand all the loan terms, your interest rate, monthly payment and applicable fees or penalties. Ensure that the offer matches what you expected. You may also want to run the numbers one final time to make sure that refinancing with your new loan offer will be more beneficial than keeping your original loan.

Don’t forget to verify whether your new lender will pay off the original loan or transfer the money to your account so you can pay off the first loan. If the lender transfers the money to you, call your creditor to get the exact payoff amount and transfer the money to them as soon as possible. You can request a written statement from your original lender as proof that your loan was paid off. Finally, set up a system to make your new loan payments on time each month.

Refinancing a personal loan can be a good strategy to save money on interest or pay off your loan sooner. There are several situations where it may make sense to refinance your loan. If interest rates have fallen or you’ve improved your credit score, you may be able to refinance to get a lower interest rate. 

You may also consider refinancing a loan if your financial situation has changed. You could look for a loan with a longer term if you need your payments to be lower or a shorter term if you can afford higher payments and want to pay off your loan sooner.

However, refinancing isn’t always the best option. If interest rates are higher or your credit score has dropped since you got your personal loan, refinancing might not save you money. Likewise, if you are early in your loan term and/or are facing a high prepayment penalty, refinancing may not be the right call. Before you decide to refinance a personal loan, be sure to weigh all the pros and cons to make sure it’s the best fit for your financial needs and circumstances.

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.