Can Personal Loans Be Refinanced?

Here's the skinny on refinancing personal loans, and how you can save hundreds or thousands of dollars by refinancing.Image source: Getty Images.

Just like any other loan, a personal loan can be refinanced to get a lower interest rate, give you more time to pay down the balance, or reduce your monthly payments. That said, whether it makes sense to refinance is largely a math problem. In some cases, refinancing your loan, even at a lower interest rate, may end up costing you more money due to origination fees or different repayment terms.

Below I'll help you navigate through the ins and outs of refinancing a personal loan, and help you decide when refinancing makes good financial sense.

Reasons to refinance a personal loan

Refinancing a personal loan makes the most sense if your circumstances have recently changed. For example, if you applied for a personal loan when you had bad credit and your credit score has improved, you may qualify for a lower rate that justifies the time and effort of refinancing it.

Here are the three best reasons to refinance a personal loan:

• Lower your APR -- Refinancing can reduce your APR and thus reduce the cost of borrowing. Lowering your APR can cut your monthly payments and save you hundreds of dollars in interest over the life of the loan.
  
  
• More time to pay -- If you have two years of payments left on your loan, but you'd prefer to pay it off in three years, refinancing is a good way to do it. That said, we'd generally discourage doing this, since increasing the term of the loan will usually cost you more in interest over the life of the new loan, even if it gets you a lower monthly payment.
  
  
• Reduce your monthly payments -- Refinancing a personal loan can reduce your monthly payments by slashing your APR, increasing the amount of time it takes to pay off the loan, or both.

Things to consider when refinancing a personal loan

It doesn't always make sense to refinance a personal loan to get a lower interest rate or monthly payment. In some cases, refinancing a personal loan may increase your payment, even if you get a lower interest rate.

There are two fees that can make it uneconomical to refinance a personal loan:

• Origination fees -- Origination fees are upfront charges that are relatively common with personal loans, though not all lenders charge them. A typical origination fee ranges from 3%-6% of the loan balance, which can typically be added to, or subtracted from, your principal amount. If you borrow $5,000 and pay a 3% origination fee, you'll either receive $5,000 from the loan and owe $5,150 in principal or receive $4,850 in loan proceeds and owe $5,000 in principal.
  
  
• Prepayment fees -- Though rare, some personal loan companies charge a prepayment fee when you pay your loan off earlier than expected. A prepayment fee is typically assessed as a flat amount ($100 or $250) or as a percentage of the outstanding balance (1%-3% of the balance is common).

Consider a case where you have 24 months of payments remaining on a $5,000 balance on a loan that carries a rate of 12%. You might consider refinancing it with a 24-month loan that has an interest rate of 10% plus a 2% origination fee.

Data source: Author's calculations.

In this scenario, even though refinancing would score you a lower interest rate (10% vs. 12%), it wouldn't make sense to refinance because the origination fee almost completely erases the interest savings. Your monthly payment would only go down by a little less than $0.03 per month, saving you all of $0.68 by refinancing. Refinancing this loan is a lot of work for almost no benefit at all.

The origination fee plays a big part in whether it makes sense to refinance. If we modify the example above by eliminating the 2% origination fee, the math completely changes. You'd save more than $170 in fees and interest by moving a $5,000 balance to be paid over 24 months from a loan with a rate of 12% to a loan with a rate of 10%. In that case, refinancing the loan may make a lot of sense.

Refinancing rarely makes sense unless one or more of the following apply:

• The rate differential is large (several percentage points).
• The new loan has a low or no origination fee.
• You have a long time remaining on the loan (time is measured in years, not months).

Whereas it may make sense to refinance a long-term loan like a mortgage to shave as little as 1% or less off your interest rate, a short-term loan like a personal loan requires a much larger interest rate differential for refinancing to make sense.

How to refinance a personal loan

The process for refinancing a personal loan is relatively straightforward. You simply need to figure out how much you will have to pay to completely pay off your existing loan, then get quotes to figure out how much you'll have to pay to borrow that much money.

Here's how to refinance your loan, step by step.

1. Get a 10-day payoff amount. Contact your existing personal loan company and ask them for a 10-day payoff amount. A payoff amount is how much money you'd have to pay to completely pay off your balance, including any interest that will accrue over the next 10 days. This is how much you will need to borrow to pay off the loan by refinancing it.
   
   
2. Apply for another loan -- Now that you know exactly how much money you'll need to refinance your personal loan, it's time to start shopping around for a better deal. Apply for a personal loan in a size roughly equal to your 10-day payoff amount. If your 10-day payoff amount is $5,940, for example, you'll likely have to apply for a loan of $6,000 to get an amount roughly equal to your existing balance.
   
   
3. Compare the terms -- If your new loan exactly matches your existing loan, then you can safely compare them based on the required monthly payment. However, if your new loan has a different loan term (24 months vs. 12 months on your current loan) comparing them isn't as easy -- we'd recommend comparing these loans based on the APR, which tells you the financing cost of the loan, including any origination fees.
   
   
4. Accept your new personal loan -- If you get an offer better than your existing loan, accept the new loan and use the proceeds to pay the 10-day payoff amount to your existing personal loan lender. After doing so, you'll have refinanced your personal loan, paying it off with a new loan on which you need to continue to make monthly payments.

Getting creative with refinancing a personal loan

You don't have to refinance a personal loan by using another personal loan. If you have good credit, you may be able to refinance a personal loan by using a balance transfer credit card. Balance transfer cards commonly offer 0% intro APRs for periods that span from six to 15 months, allowing you to move a balance and enjoy free financing for the duration of the promotional offer. (See this primer on how balance transfers work.)

To show you how a balance transfer offer can help you save money, consider a scenario where you have a $5,000 balance remaining on a personal loan with a 12% interest rate, which you will repay over 15 months. Many of the best balance transfer cards offer a 0% intro APR for 15 months, with no fees on balances you move in the first 60 days (two months) after account opening.

The table below compares the personal loan to a balance transfer credit card:

Data source: Author's calculations.

In this scenario, you would save about $409 in interest by moving a $5,000 balance at 12% to a balance transfer card and paying it off over the course of a 15-month, 0% intro APR offer.

This example was an easy one. The 0% intro APR for 15 months perfectly aligns with the 15 months of payments left on your personal loan, so it's obvious that moving the balance will help you save money. Real life isn't always so simple, so below we'll look at whether it makes sense to move your balance even if you can't pay off the balance during the 0% intro APR period.

What if you need more time than the 0% intro APR?

Because the 0% intro APR helps you pay down your balance faster, it's possible that you can save with a balance transfer card even if you do not pay off the balance in full during the 0% intro APR promotional term.

Consider this scenario where you have a $5,000 balance remaining on a personal loan with a 12% interest rate to be repaid over 24 months. If you move this balance to a credit card that offers a 0% intro APR for 15 months (18% thereafter), you'll still save money, provided you continue to make the same monthly payment.

Data source: Author's calculations.

In this scenario, moving your balance and making the same monthly payment will help you pay off the debt about two months faster, and save you more than $563 in total interest payments.

That's because during the 15-month, 0% intro APR period you will rapidly pay down your balance. By the time the 16th month rolls around, your balance will have declined to less than $1,470. Even if the interest rate is higher from that point onward, your balance is smaller, saving you money compared to the personal loan at a 12% APR.  

In short, paying a 0% intro APR on a big balance for 15 months and then an 18% APR on a smaller balance for seven months, is much better than paying a 12% APR on your balance for a 24-month period.

No matter how you do it, the main advantage of refinancing any loan, including a personal loan, is to reduce the total cost of borrowing money. People who have good credit will likely save the most by using a 0% intro APR card, while those who have some credit issues and need several years to repay their loan would be better suited with using a personal loan to refinance their existing loan.