Can You Refinance Personal Loans? What to Know
Learn how to refinance personal loans. Understand the process, preparation, and benefits for your financial goals.
Refinancing a personal loan involves taking out a new loan and using its proceeds to pay off an existing personal loan or multiple personal loans. The new loan typically comes with new repayment terms and a new interest rate, which are ideally more favorable than the original loan’s conditions.
Common Goals for Refinancing
Refinancing a personal loan aims to achieve specific financial objectives. A common goal is to secure a lower interest rate than the existing loan. If a borrower’s credit score has improved since the original loan was taken out, or if market interest rates have decreased, they may qualify for a more favorable rate, which can lead to savings on the total interest paid over the life of the loan.
Another reason for refinancing is to reduce monthly payments. This can be accomplished by extending the loan’s repayment term, spreading the outstanding balance over a longer period. While a longer term might result in paying more interest overall, it can significantly lower the amount due each month, making the debt more manageable within a budget.
Debt consolidation is a key motivation for personal loan refinancing. This involves combining several existing debts, such as credit card balances or other personal loans, into a single new personal loan. The aim is to simplify payments by having one monthly bill instead of multiple, and potentially to secure a lower overall interest rate if the new loan’s rate is less than the average rate of the consolidated debts.
Adjusting loan terms to better suit current financial circumstances is also an objective. For instance, a borrower might seek to change from a variable interest rate, which can fluctuate with market conditions, to a fixed interest rate, providing predictable monthly payments.
Preparing for a Refinance Application
Before submitting a refinance application, understand the criteria lenders evaluate. Lenders assess a borrower’s creditworthiness, including credit score, stable income, and debt-to-income ratio. A good to excellent credit score is generally needed for favorable terms.
Gather all necessary personal and financial details. You will need personal identification, such as a government-issued ID, and your Social Security number. Information about your current loan, including the outstanding balance, current interest rate, original loan amount, lender name, and account number, will also be required.
Income and employment documentation is essential. This includes recent pay stubs and W-2 forms. If self-employed, lenders may request tax returns and profit-and-loss statements to verify income and employment stability.
Bank statements for the most recent two months for all checking and savings accounts are generally required to demonstrate financial stability and cash flow. Lenders may also request statements for investment accounts or other assets. Having these documents organized can prevent delays.
Understanding your credit score is an important preparatory step. You can obtain a free copy of your credit report from each of the three major credit bureaus—Equifax, Experian, and TransUnion—annually through AnnualCreditReport.com. Many banks and credit card issuers also offer free access to your credit score, allowing you to review your credit health before applying.
Borrowers should consider the new loan’s potential terms, including the interest rate, term length, and any associated fees, in relation to their existing loan. This comparison helps determine if refinancing aligns with their financial goals, such as lowering monthly payments or reducing the total interest paid over time.
The Refinance Application and Funding Process
The refinance process begins by researching potential lenders. Explore various financial institutions, including traditional banks, credit unions, and online lenders, as they offer different terms, rates, and eligibility criteria. Compare offers from multiple lenders to find the most suitable option.
Many lenders offer pre-qualification, allowing you to receive estimated rates and terms without a significant impact on your credit score. This involves a “soft inquiry” on your credit report, providing a preview of loan options. Prequalification helps compare offers before committing to a formal application.
After selecting a lender, submit the formal application. This involves providing all previously gathered personal, financial, and employment information. During this stage, the lender performs a “hard inquiry” on your credit report, which can cause a temporary dip in your credit score.
After application submission, the lender initiates the underwriting process. This involves reviewing your financial background, including income, credit history, and debt, to assess your creditworthiness and the risk associated with lending to you. Underwriters may verify employment, income, and review bank statements to ensure the accuracy of the provided information.
If underwriting is successful, the lender will extend a formal loan offer. Review the offer carefully, paying close attention to the interest rate, repayment term, any associated fees, and the total cost of the loan. Understand all terms before accepting the new loan.
Upon acceptance, the new loan funds are disbursed. The new lender will typically pay off your existing loan or loans directly.
After the new loan funds pay off the old debt, confirm with the original lender that the account is closed and has a zero balance. You will then begin making payments on your new, refinanced loan according to the agreed-upon schedule and terms. Setting up automatic payments can help ensure timely payments and maintain good credit.