How To Refinance Your Personal Loan
April 20, 2021
Refinancing a personal loan can offer all kinds of benefits to the right borrower. By refinancing, you could get a better deal than you were originally approved for, or switch to a loan that’s more appropriate to your needs. Alternatively, it could allow you to borrow more as you access additional funds, or spread your repayments over a longer period, to make the loan more manageable.
But, while there are plenty of reasons why you may choose to refinance, refinancing doesn’t work for everyone. In this post, we’ll get into the various reasons why you may want to refinance, to then reveal the situations in which refinancing will and won’t work. From there, we’ll move on to what steps you’ll need to take to refinance your personal loan most effectively.
Reasons to Refinance
First up, why would you want to refinance? Let’s look at some of the most common reasons why borrowers choose to refinance their personal loans.
Reason 1. To Get a Better Deal
There are a few reasons why you may be able to get a better deal on a personal loan today than you got when you first applied.
Your credit score has improved
If you’ve had your personal loan for a while now, you may find your credit score has increased since you were first approved. Making your loan repayments on time each month, paying down other debts, and generally being responsible with credit should have worked in your favour to improve your credit score over time.
Why does this matter? When you apply for a personal loan, the lender uses your credit score to determine your creditworthiness – and from that, the risk on the loan. Lower credit scores typically mean higher rates, so if your credit score is higher now than it was when you applied, you could enjoy a lower rate on your refinanced loan.
Rates within the personal loan market have improved
Interest rates on personal loans rise and fall with the market. You may find that rates on personal loans when you first applied were higher than they are now, in which case, refinancing could allow you to take advantage of lower rates offered throughout the market.
If you have a variable rate personal loan, your rate should have fallen in line with the market. But, if it didn’t, refinancing could help you switch to a lower rate to save on interest. With a fixed rate personal loan, your rate will have remained the same, which means you could take advantage of lower rates by refinancing – as long as your break costs aren’t too high.
You didn’t get a good deal when you applied
Whether you didn’t take time to compare the market, or you simply didn’t know what to look for, you may have signed up for a loan that was more expensive than it should have been. If that’s the case, refinancing could allow you to get a better deal – again, as long as the cost of breaking the loan isn’t higher than the amount you would save by switching.
Reason 2. To Lower Your Repayments
There are two ways in which refinancing a personal loan can lower your repayments.
Your new loan has a lower rate
By refinancing to a new loan with a lower rate, you will pay less in interest. As a result, your repayments should be smaller.
You spread the loan over a longer term
If you’re struggling to make your repayments, you may choose to refinance your loan to take advantage of a longer term. By spreading the cost of the loan over a longer period, your repayments will decrease, making them more manageable.
|Note: It’s worth bearing in mind that by increasing your loan term in this way, you will likely pay more in interest over the long term.|
Reason 3. To Pay Off Your Loan Faster
If you’re in a better position financially than you were when you first applied, you may now have more money available each month to put towards your repayments. By refinancing your loan, you could switch to a shorter loan term to pay it off faster, potentially saving you in interest, while also allowing you to shake off your debt faster.
To make this option work for you, however, there are some conditions that apply. Namely, the cost of paying out your old loan must be lower than the amount you will save by refinancing. If your current loan allows for it, you may choose instead to make extra repayments to pay off the loan faster.
Reason 4. To Access More Funds
Most people know roughly how much they will need to borrow when they apply for a personal loan. But, there could be any number of reasons why, a few years down the line, they need to borrow more. As an example, as a borrower you may have taken out a personal loan to complete a home renovation project that grew larger than anticipated.
If you need to borrow a bit more on your loan, refinancing could allow you access to the funds you need. Similarly, if your credit score limited the amount you could borrow when you first applied, you may find borrowers are now willing to lend you more if your credit has improved.
|TIP: Made extra repayments on your loan? You could access those funds via redraw instead of refinancing your loan to borrow more.|
Reason 5. To Merge Multiple Debts
If you have a number of debts that you’re currently paying off – car loans, credit cards, store cards, hire purchase, even other personal loans – refinancing could allow you to roll them into one more manageable personal loan. Doing this could save you on interest and fees, while reducing the stress associated with dealing with multiple debts.
Reason 6. To Change Your Loan
Think your loan should be more flexible? Perhaps you don’t like the way your lender operates? Whatever your reason for not liking your current loan, refinancing could allow you to switch to a loan – and lender – that suits you better.
Switching from fixed to variable, or from basic to feature-packed flexibility, by refinancing your personal loan, you can choose the loan that suits your needs as they stand today, rather than the day you were originally approved.
|TIP: If you simply want to change your repayment frequency, the due date, or even the repayment amount (as long as you’re not on a fixed loan and the amount stays above the minimum repayment required), your lender may allow you to make those changes without you having to refinance your loan. Check with your lender first before taking any big steps towards refinancing.|
Reason 7. To Pay Off a Balloon Payment
Balloon payments are often offered on car loans. Choosing a loan with a balloon payment can significantly reduce your repayments – but, of course, you have a lump sum to pay off when the loan ends. If you don’t have the funds available to cover that lump sum, you may choose to refinance to a loan that lets you pay the amount owed off over time.
Pros and Cons of Refinancing
So, now we’ve looked at the various reasons why you may want to refinance your personal loan, let’s check out the considerations of doing so.
Save on Interest
Whether you’re refinancing to get a lower rate on your loan, or you’re consolidating a number of high interest debts into one lower rate personal loan, the main benefit you will take home is lowered interest costs. Let’s take a look.
Example A. Keri owes $15,000 on a personal loan that she’s paying back over five years. The interest rate on her loan is currently 11% p.a. By switching, she could take advantage of a much lower rate of 6% p.a., reducing the overall amount of interest paid on the loan by $2,168, from $4,568 to $2,400.
Example B. Hamish wants to consolidate his credit card debt by refinancing to a personal loan. He owes $10,000 on one credit card with an interest rate of 18% p.a., $5,000 on a credit card with an interest rate of 22% p.a., and $3,000 on a credit card with an interest rate of 21% p.a.
Paying those cards off over a period of four years, Hamish would pay $3,879 in interest on the first card, $2,417 in interest on the second card, and $1,364 in interest on the third credit card. By refinancing to a four year personal loan with a rate of 8% p.a., Hamish would pay $3,093 in interest overall, saving him $4,567.
Enjoy More Manageable Repayments
Want to lower your outgoings each month? Opting for a loan with a lower rate could give you a more manageable repayment schedule, or if you need to lower your repayments even further, you could opt for a loan with a longer term. Be aware, stretching your loan may mean you pay more in interest overall.
Example A. Owing $15,000, Keri paid $326 per month in repayments on her personal loan at a rate of 11% p.a. By switching, her repayments decrease to $290, saving her $36 per month. With this option, her loan term remains the same, and she lowers her repayments while still saving on interest.
Stretching a personal loan past five years isn’t really recommended, but it is possible. If Keri could only get approved for a loan with a rate of 11% p.a., she could refinance her $15,000 loan over six years to enjoy lower repayments at $286 – but she would pay $989 more in interest overall.
Example B. To pay off his credit cards within four years, Hamish would need to make monthly repayments of $290 on the first credit card, $155 on the second credit card, $92 on the third credit card. By rolling those debts into a personal loan with a rate of 8% p.a., Hamish’s monthly repayments would be $439. This would give him a saving of $98 per month.
If Hamish was looking to lower his repayments even further, he could opt for a loan term over five years. Doing this, his monthly repayment would be $365, which is $172 per month less than he would pay making monthly repayments on his credit cards. While his interest savings would still be significant, he would pay $806 more in interest on a five year loan compared to a four year loan.
Example C. Ivy has a $20,000 personal loan with a rate of 9% p.a. She has three years left on her loan, with monthly repayments of $636. Stretching that loan to four years (with the same rate), her monthly repayments would be $138 lower at $498. Alternatively, a loan borrowed over five years would give her a monthly repayment of $415, which is $221 less to pay each month.
However, by increasing the loan term, Ivy would pay more in interest. With the four year loan option, she would pay $994 more in interest ($3,890 compared to $2,896). With the five year loan, she would pay $2,014 more in interest ($4,910 compared to $2,896).
Alternatively, you may want to borrow more. By refinancing, you could take out a loan that not only pays off your current loan, but also gives you the additional funds you need. An example of this could involve taking out a personal loan initially to buy a project car, to then borrow more to work on the restoration.
Example D. Freddy still has $10,000 left to pay on a loan he took out to upgrade his kitchen. The loan has a rate of 10% p.a., with three years left until it’s paid off. His monthly repayments are $323, with an overall interest cost of $1,616.
Freddy wants to borrow $5,000 more to install higher end appliances in his upgraded kitchen. Keeping to a three year loan period with a rate of 10% p.a., his monthly repayment would be $484 ($161 more), with an overall interest cost of $2,424 ($808 more).
If he wanted to keep his repayment amount the same, Freddy could opt for a five year loan at the same rate, giving him a monthly repayment amount of $319. His interest costs would be significantly higher however, coming in at $4,122 ($2,505 more than the $10,000 loan over three years).
If your income has decreased or your outgoings have increased since you applied for your loan, you may be finding it harder to meet your monthly repayments as your loan progresses. Another cause for stress may lie in the number of different debts you are currently paying down, as you juggle each repayment to make sure it gets paid on time.
Refinancing your loan could help to reduce the stress you are experiencing, either as you stretch out the loan term to enjoy lower repayments, or consolidate your debts so that you only have one to deal with.
When Refinancing Will Work Well
Wondering whether refinancing your personal loan is the right choice for you? Let’s find out.
You are in a good position financially
To refinance your old loan, you will obviously have to be approved for a new loan. As such, you will need to prove to the lender that you are a low risk borrower, and that you are fully capable of repaying the amount you are looking to borrow.
During the application process, the lender will likely look at your employment status, making sure your income can cover the new loan’s repayments without it causing you financial stress. The lender will also assess your outgoings, including unpaid debts, as well as your credit report to determine your level of risk.
Your credit score has improved
One of the great things about Australia’s comprehensive credit reporting system is that borrowers’ positive actions are taken into account when determining their credit score. So, instead of only recording bad stuff, like defaults and missed payments, credit reporting agencies record positive behaviour as well, such as making repayments on time.
That means, even if your credit score wasn’t awesome when you first applied for your loan, as long as you’ve made your repayments on time, and have generally been responsible with credit elsewhere, your credit score should have improved.
How does that affect you? With improved credit, you could apply for personal loan with a lower rate, allowing you to pay off your old loan to save on interest in the long term.
You need to borrow more for a legitimate reason
While it’s not a good idea to borrow more just because you can, if you have a legitimate reason for refinancing to a larger amount, then this option could work well for you. As you can see from the above Example D, borrowing more does come at a higher cost – so make sure you can afford the extra amount added to your repayment.
Rates are much lower than when you first applied
Rates have fallen on new personal loans, but your personal loan rate hasn’t kept pace. As long as you won’t lose out on break costs and other fees, refinancing to take advantage of a lower rate on a new loan could allow you to pay off your loan sooner while saving on interest, or lower your repayments to make them more manageable.
And When It Won’t
Just as there are situations in which you may benefit from refinancing your personal loan, there are times when it simply won’t make sense.
You only have a small amount to pay off
If you only have a small amount left to pay off, you may put yourself in a worse position financially by refinancing to another loan. This could involve paying out more in interest or fees, or stretching out your loan so you stay in debt longer. Consider your options carefully before deciding whether refinancing the loan is right for you, or if you should just stick at it until it’s paid off.
Borrowing more will cause you financial stress
While we’ve talked about the benefits of borrowing more and consolidating debts, if you are already struggling financially, a new personal loan may not be the best solution. Before taking on more debt, you may be better off speaking to a financial counsellor to discuss your options and then find the one that will work best for you.
The cost of switching loans would be too high
Paying out a loan can come at a cost. Fixed rate personal loans, for example, are notorious for their high break costs. Before you think about refinancing, find out how much it will cost to pay out your old loan, then compare that to the savings or convenience offered on the new loan. If they don’t match up, you may be better off sticking with the old loan.
You think you might not be approved
If your credit is not that great, you have a number of other debts, your income has decreased or your job situation has been shaky of late, you may want to weigh up your chances of getting approved before you apply for a new loan. Getting declined will lower your credit score further, making it even harder to get approved next time you apply.
|TIP: It’s worth bearing in mind that when you apply for a loan, the lender’s hard enquiry on your credit report will cause your credit score to dip. You can work on improving it though, as you make your repayments on time throughout the loan term.|
5 Steps to Refinancing Your Loan
Confident refinancing is right for you? Let’s look at the steps you will need to take to make it work.
Step 1. Check Your Credit Score
Before you apply for a personal loan, you need to know where you stand. This starts with your credit report. You can apply for a copy of your credit report from each of the three credit reporting agencies, or you can access your report via a third party. If your credit is looking pretty average, you may want to spend time improving it before you apply.
Step 2. Compare Your Options
Compare personal loans online, checking out a range of lenders. Use a personal loan calculator to compare rates and play around with repayment schedules. Bear in mind the rate advertised may not be the rate you pay. This typically is determined by factors such as loan amount, loan term, and your credit rating.
Some lenders may provide you with an indicative rate upon request. This usually requires a soft pull on your credit report, so it shouldn’t affect your credit score.
TIP: Want to make this process even easier? At Credit World, we cut down the time it takes to compare loans, by providing you with a range of loan options suitable for both your credit score and your financial situation.
Step 3. Contact Your Lender
Now it’s time to contact your lender to get the lowdown on your loan. Find out how much it will cost to pay out your loan, and if there are any penalties you need to know about. You can use this info to compare and contrast against new loan options, making sure refinancing is actually worth your while.
|TIP: With a range of new loan options on hand, you may be able to negotiate a better deal with your lender. This could save you the trouble of refinancing, while still allowing you to benefit from a lower rate, lower repayments, or any other features you’re looking for.|
Step 4. Apply for a Loan
Once you know where you stand – and have found a loan that will give you what you need – you can begin the application process. Be sure to check the eligibility criteria and small print before you apply, and then complete the application carefully, to include all relevant documentation the lender requires.
Step 5. Pay Off the Old Loan
Depending on the lender, you may gain approval within a few hours or a few days. Once the loan has been drawn down, you can use those funds to pay off the balance of your old loan – and any penalties that have been applied. Await confirmation from the lender that your account has been closed so you can avoid any further fees and penalties.
Now, all that’s left to do is start paying down your new loan. Make sure the repayment schedule suits you – you may want to switch to weekly or fortnightly repayments – and consider setting up a direct debit payment to ensure your repayment is made on time, each and every month.