Many people don’t know how to refinance a personal loan, even though they know it is possible. Therefore, it is essential to throw more light on this crucial topic. In the right situation, refinancing your loan might be the right decision.
The new loan comes with a different interest rate when you refinance your loan. It can be a great option if your new loan has a lower interest rate. Also, a personal loan refinancing is a good choice if trying to extend your loan repayment terms.
Securing lower interest rates through refinancing makes borrowing less expensive. Therefore, the amount you will pay on your overall personal loan becomes less. Also, through personal loan refinancing, you can differ your payment term and secure lower monthly payments. However, you might incur higher interest charges on your overall cost.
Before you proceed to apply for loan refinancing, it is essential to weigh the pros and cons. Take into consideration whether refinancing can help you save costs and how it may affect your credit score. Also, consider the various steps that you need to follow when searching for a personal loan.
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What Does Refinancing a Loan Mean?
A good understanding of loans will help you know how to refinance your personal loan. In a nutshell, personal loan refinancing replaces a current loan with a new one. Refinancing your personal loan with a new one can be possible from the same lender or bank. All you have to do is check if they have an option for loan refinancing.
Once a lender approves you for loan refinancing, you will get a new loan with fresh terms. However, loan refinancing comes with its advantages and disadvantages. Therefore, weigh the odds well before applying for loan refinancing.
Also, in some instances, loan refinancing may negatively affect your loan score.
When is it Safe to Refinance Your Personal Loan?
There are a few potential advantages of personal loan refinancing. Below are some cases you may consider personal loan refinancing the best option.
- Suppose there is the possibility of securing a lower interest rate. Then, it would be best to consider refinancing: There are cases where refinancing your loan will provide you with a more favorable interest rate option. For example, if your credit improves from what it was when you first took out a personal loan, it is possible to secure a better offer. Conversely, a drop in the interest rate may also be an excellent reason to refinance your loan. However, it all depends on what you are eligible for due to your credit score.
- Cutting down on monthly payment terms: Refinancing is also an excellent way to reduce the amount you spend on monthly repayments. E.g., if you are finding it difficult to repay a 12-month loan term, you can refinance into 24 months. However, by extending your repayment period, keep in mind that this means paying more on the interest rate.
- Reducing your repayment duration: if your financial situation improves along the line, you can use a loan refinancing to lower your repayment terms. For example, you can switch from a longer payment term (48 months) to a shorter duration (maybe 12 months). In other words, with loan refinancing, you will be able to pay off your loan in a shorter period.
- There is an improvement in your credit score: A good credit score is one of the best ways to secure lower interest rates on personal loans. In addition, refinancing can be a great option if your credit score increases while you’re still repaying your former loan.
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When it is Unnecessary to Refinance Your Personal Loan
Below are some cases in which personal loan refinancing does not make sense.
- If your loan balance is minimal, refinancing does not make sense: Refinancing an existing loan when you don’t owe much is unnecessary. In addition, refinancing may incur some fees, which might adversely affect your loan amount. In situations like this, it is best to work on paying off the existing loan than incurring additional costs on your loan.
- Refinancing is a no-go area when the interest rate goes up: If refinancing does not offer you a better interest rate, it is best to think again before proceeding. There is no point continuing except if you cannot afford the payment and choose to extend the duration.
- When your term duration is almost complete, there is no point in refinancing your loan: Refinancing will only increase your term duration and make you pay more in interest.
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Steps to Refinancing Your Personal Loan
Are you ready to refinance your loan? The following steps will guide you on how to refinance your personal loan.
#1. Find out how much you need to pay off your existing loan
Refinancing means you are paying off the old loan with a new one with a new loan term. Therefore, find out the exact amount you require to settle the existing loan before searching for quotes. Also, verify if paying off an existing loan from your lender incurs a prepayment penalty. In some cases, this can be overwhelming to the benefits of refinancing.
It will do you good to contact your lender or bank to find out your outstanding payment. You can also enquire about prepayment penalties and any other additional fees that may come with refinancing.
#2. Be eligible for a new personal loan (prequalification)
Consider your credit score and report as they are the basis to qualify you for lower rates than your current payment. Many banks and lenders will provide you with their best rates. However, you must have an excellent credit rating to be eligible for this rate.
In addition, many lenders offer a free refinancing personal loan calculator to help clients calculate their suitable amounts.
You can also apply for your free credit report from the following credit bureaus:
Note that the weekly credit report now attracts some fees from the 20th of April 2022.
Another point to consider is the lender’s pull when providing you with a loan quote. Remember that a hard credit pull will hurt your credit score. Therefore, you might consider only applying for loans from lenders that provide you rates using a soft pull.
#3. Visit banks and online lenders to scout for a quote and compare rates
Carry out thorough research before refinancing your loans. Ensure to compare offers from various lenders, including their rates and terms, before settling for one. Shopping around for different quotes is essential because rates and duration differ between lenders.
Jeff Wood (Partner and CPA, Lift Financial) draws our attention to the fact that:
A current loan may incur a prepayment penalty if you wish to replace it. Therefore, it is essential to consider all the factors applicable to determine whether refinancing a personal loan makes sense.
If you require a lower monthly payment, it might be unwise to stretch a new loan duration over the existing one, especially when you are close to completing your loan repayment.
#4. Discuss with your current lender to find out if they offer loan refinancing
When scouting for personal loan refinancing quotes, consider starting with your current lender. You may be able to secure a better loan offer from your it.
Since you already have an existing relationship with your current lender, ensuring a fairer deal with them can be possible.
In addition, many lenders will not require you to make a credit inquiry to let you know if you prequalify for a loan.
#5. Proceed to apply for your loan and use it to pay off the current loan amount
When you decide on the lender to settle with, apply for a loan and submit all necessary documents. A formal refinancing application requires a loan underwriting and a proper application to receive funds from a lender.
Some lenders may transfer funds to your account, while others decide to pay off the existing loan directly. Check to ensure no pending balance on your former loan to avoid additional payments.
Once you clear your current loan, begin making a payment towards the new one. Some lenders will provide you with the opportunity to set up recurrent amounts from a checking account.
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Refinancing a Personal Loan Can Affect Your Credit Score. Here is How it Does
Refinancing your personal loan makes you subject to credit checks. As a result, it can temporarily reduce your credit score, particularly for those who practice good financial practices with their new loan.
On the other hand, new accounts and credit inquiries may hurt your credit score in the short term.
However, making a one-time payment towards settling your new loan will improve your credit score in the long run. Remember that a negative score may have a long-term effect if you have huge capital project plans.
Some of the reasons why you experience a drop in your credit scores are:
#1. Hard Credit Check
One of the criteria for loan refinancing is a hard credit check on your credit score and account. When you’re scouting for a loan lender, submitting your loan applications with different lenders within fourteen days is essential.
Most credit-scoring platforms regard multiple applications within fourteen days as a single application (not in all cases). However, where applicable, it can reduce the impact of inquiries on your credit score.
#2. Closing of Account
When your refinancing is successful, it will lead to closing your initial loan account. Some credit scoring platforms regard loans for debt repayment as negative loans in ways that do not apply to car and home loans.
Also, credit scoring systems consider the duration of accounts on your credit report. So while some consider the old loan during calculation, others don’t, which can affect the average score.
According to the FICO credit scoring model, the duration of credit history accounts for 15% of the general FICO credit score.
#3. New Credit
If you have recently received loan offers or credit, it can affect your credit score adversely. Many credit-scoring models regard several new short-term accounts as a potential risk.
Pros and Cons of Refinancing a Personal Loan
When you understand how to refinance a personal loan, here are some benefits. However, goals determine how beneficial refinancing a personal loan will be. The benefits usually range from better rate offers to the general cost of the loan plan.
While considering the benefits, don’t forget that personal loan refinancing also comes with drawbacks. Therefore, it is also essential to consider the disadvantages before settling for loan refinancing.
Improved interest rate: if your credit scores have become better or there is an improvement in rate, you enjoy savings on the interest rate.
It is the quickest way to pay off your loans: if you can afford to make higher monthly payments and be free from debt faster, refinancing to a shorter term can be beneficial. It also reduces your overall interest rate.
It serves to extend your repayment duration: if you’re facing challenges with your current repayment plan, extending your loan terms can make it more manageable. Extending your loan term can reduce your monthly repayments and make it easier to manage.
It can improve payment stability: refinancing a personal loan can improve payment stability, especially if you want to switch from a variable to a fixed rate.
- Extra charges: Refinancing a personal loan can lead to additional charges, including a lender fee.
- You may incur prepayment penalties: Paying off a loan balance before the duration can lead to a prepayment penalty. Consider revisiting your loan terms since refinancing a personal loan requires you to pay off the existing loan.
- It increases the interest rate due to the extension of the loan duration: loan refinancing can cause you to pay higher interest rates over time. Refinancing might be a great choice if your goal is to cut down on monthly repayments. But, it will cost you more on interest in the long run.
- It can negatively impact your credit score: refinancing falls under a new loan offer. Therefore, it can affect your credit score negatively, even though the impact may be insignificant or temporal.
- Researching for a new loan offer can be time-consuming: finding new lenders is not always a walk-over situation. Instead, it takes time and energy.
Knowing how to refinance a personal loan is essential. Ensure that you understand how the process works before jumping to a conclusion. Try to answer some critical questions, like will I secure a lower interest rate? Can I reduce my monthly repayments with refinancing? Will refinancing provide better loan terms? Also, explore the benefits and disadvantages of loan refinancing before venturing into it.
Once you conclude your research and decide on the best lender for you, you may proceed to apply for personal loan refinancing. Ensure to handle any new loan maturely if you want to maintain an excellent score.
FAQs on How To Refinance Personal Loans
Yes. So long as the bank offers personal loan refinancing and you are eligible, you can apply for loan refinancing from the same bank.
Usually, how soon you can refinance a personal loan depends on your choice of lender. Before you consider a lender, check how fast they process their loan. Some offer same-day delivery of funds, while others take as much as ten working days to deliver funds. Consider going for lenders that provide quick funds if you require immediate cash.
Yes, and in some situations, you should. When you refinance your loan, ensure that you get sufficient funds to clear your current loans and cover additional fees like prepayment penalty and origination charges. You can also increase your funds to cater for other additional loans you may be owing.
Some lenders clear your current loan directly, while others pay money into your account. However, loan refinancing aims to help pay off existing loans and have enough to pay for lender charges and other additional fees.
Yes, you can refinance your personal loan with a navy federal personal loan.
Yes. Refinancing your personal loan can affect your credit score. However, the effect is usually temporal. As long as you make a one-time full month’s payment for your loan, the impact of refinancing on your score will be temporal.
If you qualify for a lower rate, it is reasonable to refinance your personal loan.
- Nerdwallet.com—How To Refinance a Personal Loan
- Bankrate.com—When and How to Refinance A Personal Loan
- Creditkarma.com—When and How to Refinance a Personal Loan