Refinance a personal loan only when the new annual percentage rate (APR), which includes any origination fee, beats the interest rate you pay now. Then compare total cost rather than the monthly payment, since a longer term can wipe out the savings, and count any prepayment penalty your current loan charges.
The usual reasons to refinance are good ones: a credit score that has climbed since you borrowed, lower rates across the market, a cosigner who wants off the loan, or a payment that has gotten hard to make. Lenders pitch the lower rate and the smaller payment, though, and neither number tells you whether you come out ahead.
Two things settle it, plus any penalty your current loan charges for paying it off early. The first is the origination fee, which usually comes out of the new loan itself, so you borrow more than you now owe. The new loan’s APR counts that fee as well as the interest, which makes it the number to compare with the interest rate on your current loan. Use that loan’s rate, not its APR, since the fee you paid to get it is already spent.
The second is the term. A later payoff date shrinks the payment, but the extra months of interest can cost more than the lower rate saves.
Say your loan has no prepayment penalty and you owe $12,000 at 22% interest with three years left, a payment of about $458 a month. A 12% loan with a 4% fee means borrowing $12,500 to clear it. Its APR works out to about 14.9%, well under 22%. Keep the three-year term and the payment drops about $43 a month, which saves roughly $1,550 in total, after the fee. Stretch that loan to five years and the payment falls to about $278, but you’d pay about $185 more than if you’d kept the old loan.
Check your current loan agreement for a prepayment penalty and count it as part of the cost. The application also adds a hard inquiry, which for most people takes less than five points off a FICO score and stops counting after a year.
If the new loan’s total cost comes out higher than the old one’s, you’re paying extra for a smaller payment. Take that deal only when the payment itself is the problem.
If you’re shopping for a new loan, compare the best personal loan companies.
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