Before You Refinance a Personal Loan, Do This

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  • Refinancing a personal loan could result in a lower interest rate on it.
  • Before you go that route, there may be another type of refinance worth exploring.

It's an option worth looking into.

The great thing about personal loans is that they allow you to borrow money for any purpose. With a mortgage, for example, you're limited to using those funds to purchase a home. With a personal loan, you can borrow money to start a business, take a vacation, or pay off a chunk of credit card debt.

The interest rate you get on your personal loan will generally hinge on factors like your credit score and the sum you're borrowing. Market conditions will generally also affect your loan's rate.

There may come a point when it's possible to refinance your personal loan and lower the interest rate you're paying on it in the process. But before you take that step, it could pay to look into a different type of refinance.

Should you tap your home equity to pay off debt?

These days, U.S. homeowners are sitting on a record level of home equity due to soaring property values. And that means you may have a fairly easy time qualifying for a cash-out refinance.

With a regular mortgage refinance, you borrow the exact sum you owe on your existing home loan. With a cash-out refinance, you borrow more than your remaining mortgage balance, and you can use that extra cash for any purpose. In that regard, a cash-out refinance functions similarly to a personal loan.

So why might you refinance your mortgage instead of your personal loan? It's simple. Even with mortgage rates being higher these days than they were last year, you might still snag a lower interest rate on a cash-out refinance than you will with a personal loan. If you go the cash-out refinance route, you can use your proceeds to pay off your personal loan and then pay off your mortgage at what could be a lower interest rate than what you're paying today.

Is there a downside to doing a cash-out refinance?

A cash-out refinance is a loan you're responsible for paying. That's why it's important to borrow carefully.

If you limit the sum you borrow via a cash-out refinance to your remaining mortgage balance plus your personal loan balance, you're not putting yourself in any worse a position, because those are debts you're liable for right now. What you don't want to do, however, is go overboard on borrowing with a cash-out refinance just because you can.

Say you owe $200,000 on your mortgage and $10,000 on your personal loan. In that case, there's really no need to borrow more than $210,000. But if you borrow $230,000 simply because the option exists, you'll have a much higher monthly mortgage payment to keep up with. So unless there's a reason for taking another $20,000 in cash out of your home, you're better off sticking to that lower amount.

While personal loans can offer competitive interest rates, you might reap even more savings on interest by using a cash-out refinance to settle up your personal loan balance. If you're going to go this route, shop around with different refinance lenders to make sure you're getting the best rate you're eligible for.

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