Personal loans are a great way of spreading the cost of a big purchase or life event over a few years, but sometimes there can be circumstances where it makes sense to refinance a personal loan. Using a loan repayment calculator can help you to see the potential savings you could make if you were to refinance, but that isn’t the only factor to consider.
What is Refinancing?
Refinancing a loan is when you take out a new loan to pay off an existing one. People will usually look to refinance a loan if they have found that a better interest rate is available; having a lower interest rate would mean they end up paying back less overall.
It can also be worthwhile refinancing a loan if they find one with the same interest rate, but over a longer-term; this can help make repayments more affordable. Be sure to weigh the benefit of lower payments against the potential higher lifetime cost of extending the term.
When Does It Make Sense to Refinance a Personal Loan?
The main benefits of refinancing a personal loan are that, if done correctly, it can save you money on the interest you would have been paying and also potentially make the monthly repayments more manageable.
Here are some of the situations where it can make sense to refinance a loan:
Your credit score has improved
Having a higher credit score can mean you are eligible for access to better interest rates and terms on personal loans. If your credit score has gone up since you first took out your personal loan, it can be worth checking to see if new rates are available.
Changing to a different type of rate
If your original loan was taken out on a variable interest rate, switching to a fixed interest rate could help save money on interest and make your monthly repayments lower and more predictable.
Your income has dropped
If you’ve experienced a drop in income, you may find that your fixed monthly payments on your current loan are a bit too high. Even if you can’t get a new loan with a lower interest rate, a new loan over a longer-term can help to reduce the monthly payments you need to make. This option won’t necessarily save you money, but it can help lessen the financial strain.
Your income has risen
If your income has recently risen, it might have made a change to your debt to income ratio (also known as DTI. Having a higher income and lower DTI can mean you can get a better interest rate on a new loan.
There could also be the option to pay your loan off more quickly to save money on the overall interest. For example, suppose you can afford to make larger monthly repayments. In that case, you could refinance over a shorter loan term, reducing the overall interest paid back and getting it paid off sooner.
Don’t forget about Fees
Refinancing can include paying origination or application fees. When deciding whether a refinancing will save you money, accounting for new fees and the total lifetime interest cost are important.