Personal loan refinancing: How it works and who should consider it

Personal loans offer quick cash with no collateral requirements. Due to the same they have become a popular choice for people who do not own assets but require funds for emergencies, events, and other personal needs. However, these loans often provide an option of refinancing, which can be a smart choice if prior planning is done. 

Refinancing a personal loan permits borrowers to replace their existing loan with a new one at better terms, be it lower interest rates, reduced EMIs, or improved repayment flexibility. Let us understand this in detail.

Understanding personal loan refinancing

Personal loan refinancing is when a person takes a new personal loan to pay down the old personal loan. The new loan can be with the same lender or a new lender, and it will normally have better terms. The main reason for refinancing is to reduce the cost of borrowing or the monthly EMI, or extend the repayment tenure as per the financial needs and aspirations of the borrower.

Key advantages of personal loan refinancing

• Reduced EMI burden: Refinancing can reduce the EMI burden by extending its tenure. With this, the loan repayment will be more manageable.
• Lower interest rates: Refinancing will help in getting lower interest rates if your credit score has improved drastically or the interest rates have decreased.
• Better loan terms: New lenders may offer you better terms, including no prepayment charges, reduced processing fees, and even flexible repayment options.
• Debt consolidation: A number of loans can be refinanced and consolidated into one loan for easier management.
• Better financial management: If your income has increased or your expenses have, refinancing your loan will help you redo your budget and also help you relieve yourself of some of your financial burdens.

Steps to refinancing your personal loan

1. Assess your existing loan: Before you go for refinancing, assess your existing loan and check if your existing loan interest rate, outstanding tenure, outstanding balance, and prepayment charges are in your favour. It helps in deciding whether refinancing is a good idea.

2. Compare loan offers: Compare the loan offers from other lenders with your current loan as well as your budget. In this way, you will be able to avail yourself of a better deal on your loan.

3. Check eligibility: Understand the eligibility criteria required by lenders, which mainly involve credit score, income, employment status, and repayment history. In most cases, a credit score of 750 and above gives you better odds of having lower interest rates.

4. Apply for a new loan: After choosing the lender, apply with a refinancing application with documents like identity proof, income proof, details of the existing loan, and the bank statements.

5. Loan approval and disbursement: The new lender would either transfer the loan amount to your account or pay off the existing loan’s outstanding balance directly.

6. Close the old loan: Make sure that you properly close your personal loan with your previous lender.

Factors to consider before refinancing your personal loan

• Prepayment charges: Some lenders charge a prepayment penalty for early loan closure, which may reduce the overall cost benefits of refinancing.
• Applying for a new loan: A hard inquiry on your credit report can temporarily lower your credit score.
• Processing fees and other charges: New loans may have processing fees and other additional charges, which may increase the overall cost of the loan.
• Total loan cost: Lowering the tenure will reduce EMI but will also increase the total interest paid over time.
• Loan terms and conditions: Make sure that the new loan offers better value than your previous loan structure.

To better assist in refinancing you can begin the process by practicing the 2% refinancing rule. 

What is the 2% rule of refinancing?

The 2% rule for refinancing suggests that refinancing a loan makes both logical and financial sense if the new interest rate is at least 2% lower than the current one. Such an approach ensures meaningful savings on interest costs and monthly repayments. 

Hence, this rule serves as a simple, general guideline; still, as a prudent borrower, one should also consider other important factors such as processing fee, loan tenure, prepayment penalties, and overall savings before refinancing, to boost the decision of refinancing. Finally, the decision on refinancing should only be taken after proper guidance from investment professionals. 

In conclusion, you must note that personal loans have higher interest rates compared to other loans offered in the market. Refinancing your personal loan can be a wise decision if you plan your finances carefully. However, before you decide on refinancing the loan, make sure you analyse both scenarios carefully so that you can get the best deal for yourself.

For all personal finance updates, visit here.

Disclaimer: Mint has a tie-up with fintechs for providing credit; you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards, and credit scores. Mint does not promote or encourage taking credit as it comes with a set of risks, such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.