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Can You Refinance a Personal Loan?

Christy Bieber, The Motley Fool

If you're paying back a personal loan, can you refinance it, or are you stuck with the loan until you pay it off? Find out here. 

Woman handing paperwork to bank.

Image source: Getty Images.

You've probably heard of refinancing loans. It’s pretty common for people to refinance mortgages, and student loan refinancing has also become popular in recent years.

But, what if you have a personal loan? Is it possible to refinance it? The answer is yes -- you aren’t stuck with your personal loan until you repay it. However, before you decide that refinancing a personal loan is the right choice for you, you need to explore your options and make sure you understand how the process works.

How do you refinance a personal loan?

To refinance a personal loan, you need to get a new loan from any source and use that loan to pay off the personal loan you currently have.

You could obtain a new refinance loan from your existing personal loan lender. Or, you could go to a different personal loan lender to obtain a new refinance loan.

Some people also use credit card balance transfer checks to refinance a loan. If you have a credit card offering a 0% promotional interest rate, you could use the balance transfer checks to pay off your current personal loan. Since you’d now have a new loan on new terms, this is a form of personal loan refinancing.

Should you refinance a personal loan?

While you can refinance a personal loan, this doesn’t always mean doing so is a good idea. You’ll need to carefully weigh the pros and cons of refinancing your existing loan to decide what’s best. The factors to think about when deciding if you should refinance include:

  • Whether your current loan has a prepayment penalty. When you refinance a personal loan, you pay off the existing loan with the proceeds from your new loan. Since you’re paying off the loan early, this could trigger a prepayment penalty -- if your loan has one. The prepayment penalty could negate any savings that comes from refinancing.

  • Whether you can qualify for a new loan with a lower interest rate. The purpose of refinancing is usually to make debt repayment easier -- often by lowering the rate you pay on what you owe. You’ll need pretty good creditand a decent income to obtain a good refinance loan. If you can’t qualify for a lower interest rate loan, refinancing likely isn’t a smart choice. Your new loan would end up costing more than just paying off your existing debt if you have to pay more interest.

  • The repayment period on your new loan. It may be tempting to get a refinance loan with a longer repayment timeline than your existing loan. Stretching out your repayment time reduces your monthly payment -- even if your interest rate doesn’t change. Although a lower monthly payment seems tempting so you have more money in the short term, you end up paying interest for longer and increasing your total loan costs. Try to keep the repayment timeline the same, or make it shorter, so you can minimize interest and become debt free more quickly.

  • The monthly payment.If your new loan has a lower interest rate and a shorter repayment timeline, but the monthly payment isn’t affordable for you, don’t take out the new loan. You don’t want to put yourself in a position where you can’t pay the bills.

Reducing interest rates is one of the most common -- and best -- reasons for refinancing. If you reduce interest, less of your money goes to the lender. With each payment you make, you pay a bigger amount of principal and less interest. With more of your money going toward paying down your loan balance, you become debt free faster.

Some people also decide to refinance to simplify debt repayment. If you have multiple loans, you could get one new loan to pay them all off. This is called consolidation, but it’s also a form of refinancing since you’re changing the terms of all your existing debts.

How to find a refinance loan

If you’ve decided you want to refinance your personal loan, your current lender is a good place to start. You can talk with the lender about refinance loan options. If you can qualify for a loan with a lower APR from the same lender, refinancing should be simple.

You should also comparison shop among other lenders to see if they’ll offer you an even better deal than your current lender. If your current lender will refinance a loan at 9% and you could opt for a different lender to refinance your loan at 7%, you’d likely be better off going for the second lender -- assuming fees and costs were comparable. It’s not a big deal to get a new loan from a different lender in most cases, so don’t feel like you have to be loyal to the financial institution you’re currently borrowing from.

You’ll want to pay careful attention to the terms of the new loan, regardless of which lender you choose. Ideally, your interest rate will drop, and your monthly payment will stay close to the same as what you’re paying now. If this happens, you should become debt free more quickly since you’re paying the same amount, but less of your money is going to interest. Don’t take out a refinance loan with a higher interest rate than you’re currently paying and don’t be fooled by the promise of a low monthly payment if the payment is only low because the loan has such a long repayment term.

As you comparison shop for refinance loans, watch out for teaser rates and fees. Many refinance loans start out at a low teaser rate but the rate jumps up quickly. If that’s the case, you could end up paying more interest once your rate rises compared with your current debt. And if the refinance loan lender charges substantial fees, you could negate any savings that might come from refinancing.

Refinancing a personal loan is definitely possible

Now you know that refinancing a personal loan is definitely possible -- but you shouldn’t refinance unless you can make sure you find the best new loan for your situation. Compare all of your options, look at the interest payment and total cost of loan repayment, and make the choice that’s right for you.

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