Watch Out for This Pitfall if You're Using a Personal Loan to Refinance Debt

Don't refinance debt using a personal loan until you read this.

If you have a lot of debt, you may be interested in using a personal loan to refinance it. That involves applying for a new personal loan from a lender and shopping around to get the most competitive rate you can find. Once you've been approved for the loan, you use the money given to you to repay your other more expensive debts.

Since your personal loan can change your financing terms in a favorable way, this approach can often save you a lot of money and make it easier to become debt free. But there's one key pitfall you need to watch out for to make sure your loan saves you money. You can't just assume that you'll always be better off if your new loan has a lower rate.

Be on the lookout for this issue when refinancing using a personal loan

If you want to make sure your personal loan saves you money as a result of refinancing, the one thing you need to watch out for beyond the interest rate is the repayment timeline on your new loan.

You will usually have a choice for how long the payoff period should be when you take out a personal loan. It could range from as little as a year or two to five or 10 years or sometimes even longer. And loans with longer payoff times can seem very attractive because between the lower rate and the fact you're stretching out your payment schedule, you can end up with very low monthly payments.

The only problem is, loans with long repayment timelines can end up costing you more in the end than your existing debt would have cost you -- even if you've lowered your rate. Say, for example, you have two years left to pay off the debt you are refinancing and you get a new loan with a 10-year repayment schedule.

The fact that you have added eight years of interest payments by refinancing means your new loan is almost definitely going to be more expensive even if you've managed to drop your interest rate considerably.

How to make sure your refinance loan saves you money

If you want to be sure your new refinance loan is a good deal and the right choice for your finances, you should try to keep your payment schedule the same when you refinance or even shorten your payoff time if it is possible to do so.

If you can choose the personal loan with the shortest payoff schedule that fits into your monthly budget, you can save a lot of money by lowering your rate and paying the bank interest for less time. You won't need to worry that years of extra interest adds to your total costs. And you'll benefit from being able to retire your debt ASAP so you can start using your money for other things.

You should shop around among several different personal loan lenders before you decide who to refinance with, and by taking both interest rate and payoff time into account during this process, you'll hopefully end up with a loan that's right for you.