Taking a loan to pay off debt can help you manage your finances. However, when you start paying back the debt, it may soon become obvious that refinancing was a better option.
Refinancing a personal loan means replacing an existing debt with a new one that has better terms. In simpler terms, you can describe refinancing as taking a new loan and using the money to pay off your existing debt. After doing that, you will start to make repayments for the new loan with new terms and interest rates.
One of the main reasons why refinancing makes sense is that the borrower gets a loan with better interest terms. Secured personal loans like mortgages or car loans are not always easy to refinance. This is because they come with penalties for repaying early. On the other hand, refinansieringor refinancing unsecured loans is a lot easier.
In this article, we will discuss the reasons why people choose to refinance their loans. We will also consider the important steps to take if you want to refinance your debt.
Now, let’s start with the reasons why one can choose to refinance their loans.
Reasons Why You Should Refinance a Personal Loan
The following are some reasons why one can choose to refinance debt:
An Improved Credit Score
If you have an improved credit score, then you can refinance a loan. This is one of the criteria that make refinancing possible. It is therefore wise to check your credit score constantly.
A Better Interest Rate
Most unsecured loans have a variable interest rate and this makes it difficult for one to have a repayment plan. Variable interest rate increases the monthly bill amount. With this in mind, refinancing allows you to change from a variable to a fixed interest rate. This rate is more suitable for any repayment plan.
This is common in mortgage and commercial loans. The balloon payment is the final payment made to balance off loan debt. It is always larger than the other payments made throughout the loan duration. By refinancing loans, borrowers can avoid this balloon payment.
Change in Financial Status
It is possible for your financial status to experience a change. When you had a high paying job, it was easy for you to afford the high monthly loan payments. But now, things have changed. If you lost your job, you will start looking for ways to lower the monthly loan bills. This is where refinancing comes in. By refinancing a loan, you lower the monthly payment to what you can afford.
Important Steps to Take When Refinancing a Personal Loan
Here are some important steps to take:
Know How Much You Need
When refinancing loans, you are paying off existing debt with a new one. You have to make sure the new loan can cover for the existing debt. Ensure that you determine the actual amount left in the current debt.
When you contact your lender, ask if there are any penalties for early payments. Prepayment penalties always affect refinancing negatively and you can see some of the impacts here:
Confirm Your Credit Report and Credit Score
One important step to take when considering refinancing is checking your credit report. You can find your credit score in this report as it shows your debt status, repayment and credit history. A credit score can affect your financial life because many lenders do not approve loans for people who have poor credit scores. So, it is very important to maintain a good credit report.
Paying up your debt early is one way to improve this score. If you would like to see your credit report, contact your financial institution for it as they willingly give it out to their customers for free.
Having a poor credit score doesn’t mean that you cannot get new loans because some lenders offer loans that accept low credit. These loans though come with higher interest rates. This is why it is important to maintain a good credit score as it allows you to qualify for loans with a lower interest rate.
Make Research for Lenders
Search for available lenders online and compare their rates and terms. If possible, ask your current lender if they refinance loans. If they do, ask them what their terms are. If the terms are favorable to you, then you may decide to consider them. If not, continue your research.
The main purpose of refinancing is to find a loan with a better offer than your current one, so keep this in mind during your research. Some third-party websites make things easy for you. These sites take their time to research the best loan offers out there and then display them on their website. All you have to do is choose the offer that is most appealing to you.
Some lenders may promise an interest rate that seems impossible. If you are suspicious about the terms, do not bother taking the loan. Confirm the reputation of any lender you want to consider. What do people say about their services? Check their websites for customer reviews.
Apply for Refinancing
Once you have decided on the lender whose offer suits your need best, fill out the application form. The lender will ask for the necessary documents. Make sure you have them with you.
Also, ensure to read through the terms of a loan before accepting it. The terms will include your monthly payment schedule, different fees and prepayment penalties. Make sure there are no hidden fees in the monthly bill schedule. If there is anything you do not understand, be free to ask the lender. When you are satisfied with the terms, you can accept the offer.
After accepting a loan, most lenders will send you the money within a few days. After receiving the money, use it to pay off your current debt. Do this immediately to avoid making double monthly payments. Once that is done, focus on repaying the new loan.
Pros of Refinancing
The following are some benefits of debt:
Better Interest Rate
Refinancing allows you to have a better interest rate than your current one. This is especially possible if you have a good credit score. Having good credit allows you to get a lower interest rate for loans. This will in turn save you some money.
Reduces Your Monthly Payments
You can reduce your monthly payment by increasing your loan duration. In case you start earning lower than before, you can refinance your loan term by extending the duration. For instance, if you are expected to pay off the debt within 24 months, you can refinance it to 36 months. This will reduce the monthly bill you pay.
Paying Loans Faster
To pay off loans faster, you can change the duration from a longer period to a shorter one. Reducing the duration will help you get out of debt faster.
Cons of Refinancing
Before you try out refinancing, consider some of its downsides:
When you refinance to extend your loan duration, you also increase the interest rate. Although the monthly bill becomes low, the total interest rate increases. So, in the long run, the total amount you will pay becomes higher than what you would have paid for a short loan term.
Some lenders collect certain fees like the origination fee, appraisal fee and processing fee. By paying these fees, you may end up paying more at the end of a loan term. So before taking on new loans, make sure you compare the terms with the current one. Just jumping into any refinance offer will not help you at all.
Some loans come with a penalty if you pay off the debt early. Since refinancing involves paying off existing debt with a new one, it is wise to confirm if the new loan doesn’t come with a prepayment penalty.
It is necessary to make research before choosing any lender services but this can be time-consuming. If your existing debt is almost close to being balanced off, refinancing might not be necessary.
If you have a personal loan and wish to refinance it, make sure you compare the pros and cons before making a decision. This comparison will help you decide whether refinancing is a good option or not. If you decide to refinance, ensure that you follow the stated steps above.