When to refinance a personal loan and how much lower the rate must be to pay off

Quick Answer

It rarely pays when little time remains on the current loan. Prequalify with soft inquiries to see the rate your score earns today.

Optimal times to refinance personal loan

Refinancing a personal loan pays off when a new loan has a lower APR or terms that fit your budget better. The total cost of the new loan, including any fees, must be less than the cost of keeping your current loan. It rarely pays to refinance when you are near the end of your current loan term.

The loan term affects your monthly payments and total interest

The loan term is the set period of time you have to pay back the full balance. It is determined by the number of months or years agreed upon in your contract. Extending this period can lower your monthly payments but may increase the total amount of interest you pay.

Compare current debt against market offers

To determine if you should move forward, see how interest rates are set and compare your current debt against market offers. You can save money if the new interest rate significantly decreases your monthly obligation. Verify that the new loan’s total repayment amount is lower than your remaining balance plus future interest.

The interest rate determines your total cost of borrowing

The interest rate is the percentage of the loan amount charged by the lender over time. It is calculated as a cost for borrowing money and is usually expressed as an annual percentage.

When does it pay to refinance a personal loan?

Refinancing pays off when the new loan’s APR is clearly lower than your current rate. You should also check if the new repayment schedule fits your monthly cash flow. Calculate the total cost of the new loan to ensure the fees do not outweigh the interest savings. If you are close to finishing your current loan, the remaining interest may be too low to justify the cost of a new application.

How much lower must the rate be for savings?

The interest rate must be low enough to offset the cost of a new loan and reach a break-even point. Before you proceed, check personal loans with bad credit to ensure you refinance only if the monthly interest savings exceed the upfront fees within the time you plan to keep the loan.

1. Identify the total cost of the new loan, such as an origination fee.
2. Calculate the monthly interest savings by subtracting the new interest payment from the current payment.
3. Divide the total cost of the new loan by the monthly interest savings to find the break-even point in months.
4. Compare the break-even point to your planned loan duration to see if the move saves money.

Debt consolidation loan savings table

Assume a borrower has a current loan with a monthly interest cost of $100. The monthly saving is $30.

Calculating the break even point for a personal debt consolidation loan

To calculate the break-even point, divide the cost of refinancing by the monthly saving. Before you proceed, see how your score affects rates. If you keep the loan longer than the result of this calculation, the new loan saves money.

Costs that can cancel personal loan savings

An origination fee on a new loan or a prepayment penalty on an existing loan can cancel the savings from a lower interest rate. Borrowers should weigh how a credit union loan differs from a bank loan to determine if a lower rate actually reduces the total cost of the debt.

Potential penalty fee list

• Borrowers should check the loan agreement to see if the lender charges an origination fee to process the new application.
• A prepayment penalty might apply to the current debt if the lender charges a fee for paying off the balance early. A prepayment penalty is a fee charged by a lender if you pay off your loan balance before the scheduled end date.
• Lenders often disclose these costs in the loan estimate or the final promissory note.
• The cost of a new loan can offset the interest savings if the fee is high relative to the loan amount.
• A borrower may choose to refinance a personal loan only after calculating the net savings after all fees.

Which fees or penalties can cancel the savings?

An origination fee is a cost a lender charges to set up a new loan. A prepayment penalty is a fee charged for paying off a loan before the end of the term. Both costs can exceed the amount a borrower saves by securing a lower interest rate.

Does stretching the term make refinancing a bad idea?

Stretching the loan term can make refinancing a bad idea if the goal is to minimize total costs. While a longer loan term decreases the monthly payment, it increases the total interest paid over the life of the loan. A lower monthly payment does not always result in a better financial deal.

Compare total interest on both loans

Borrowers should calculate the total interest on the current loan and weigh how unsecured loans differ from the projected total interest on the new loan. This comparison helps determine if the lower interest rate offsets the cost of a longer repayment period. If the total interest on the new loan is higher, the borrower pays more for the convenience of lower monthly payments.

Will refinancing hurt your credit score

Applying for a new personal loan requires a hard inquiry, which can cause a temporary dip in a credit score. A credit score is a numerical rating that represents your history of borrowing and repaying money. However, paying off the original debt and establishing a history of on-time payments on the new loan can improve a credit score over time.

Credit requirements to refinance an unsecured loan

Lenders typically require a high credit score to offer the lowest interest rates on a personal loan. A higher score signals lower risk to a lender. You can prequalify for a loan to see the specific rate your current score earns today without affecting your credit report.

Improve credit score for lower rates

Lenders award lower rates to borrowers who maintain strong credit profiles. Improving your score since your original loan application makes refinancing more likely to lower your costs. Prequalification helps you figure out current terms before you apply for a final loan.

Unsecured loan eligibility requirements

• Lenders review your credit score to determine the interest rate for a new loan.
• Debt to income ratios help lenders assess your ability to pay back the loan.
• Employment history provides evidence of steady income to cover monthly payments.
• Previous loan repayment history impacts the risk level a lender assigns to you.
• Current outstanding debts influence the total amount of credit a lender will extend.

Is a balance transfer a better way to refinance?

A balance transfer might be a better way to refinance if you want to move credit card debt to a new account with a lower interest rate. A balance transfer is the process of moving an existing debt from one account or loan to a different one. Personal loan refinancing remains a better choice for consolidating multiple types of debt into a single monthly payment with a fixed term.

Who gains most from refinancing

Borrowers whose credit improved

If your credit score is higher than when you first borrowed, you may now qualify for a lower rate than your original loan. No single score is required, but lenders reserve their best rates for strong scores, so a score higher than when you first borrowed makes a better rate more likely; prequalify to see yours.

Borrowers with a high-rate loan

You have a high-rate loan and your rate is far above current offers. Refinancing is most likely to save money here.

Borrowers near payoff

If only a few payments remain, fees may outweigh any saving. Check the break-even point.

Refinance mistakes that cost money

• Ignoring fees on the new loan can cause a fee to wipe out the saving from a lower rate.
• Stretching the term without checking total cost can cause total interest to rise even when the payment drops.

How to determine if you should refinance a personal loan

Deciding to refinance a personal loan requires a clear understanding of your current debt and potential new costs before comparing offers.

Refinancing decision checklist

1. Find your current payoff amount and APR. Locate your most recent billing statement. Identify the exact total required to close the account and the current annual percentage rate.
2. Prequalify with several lenders. Submit applications to multiple providers to see what rates they offer. Compare these offers against the 11.90 percent average reported by the Federal Reserve Board, G.19 Consumer Credit.
3. Add up all fees on the new loan. Request a full breakdown of origination fees, processing costs, and closing charges from the new lender. Sum these to find the total cost of the new loan.
4. Compute the break-even point. Divide the total new loan fees by the monthly savings between the old and new interest rates. This number shows how many months of payments it takes to recoup the costs.
5. Check the old loan for a prepayment charge. Ask your current loan provider if there is a penalty for paying the balance early. If the fee is high, it may make refinancing less profitable.

Frequently asked questions