Refinancing loans can offer several benefits, however, it is important to be aware of the potential drawbacks. Before deciding to refinance your loan you should weigh the pros and cost carefully to make sure you understand the cost and risk of making the switch.

Here are some advantages and disadvantages of refinancing personal loans:

Advantages of refinancing personal loans.

Lower interest rates: When you refinance a personal loan you will have an opportunity to secure a new loan with a lower interest rate than you currently have. This will result in several benefits such as lower monthly payments and significant savings over the life of the loan. If you lower your monthly payment this can especially be helpful for borrowers that are struggling to make payments because it will lower your monthly payment and will make it easier to manage your cash flow.

Refinancing your loan can lead to significant savings, even having a small reduction in interest can have a large impact on the money you save over time. For example, if you have a $30,000 loan over 5 years with a 10% interest you will pay $7,620 of interest while with 6% interest, you will only end up paying $4,160 in interest over time saving you over $3,400.

Refinancing a low with lower credit is a smart financial move that can help borrowers save money. 

Improved loan terms: Refinancing a loan is a popular financial strategy that will allow borrowers to adjust the terms of their loan to better fit their financial needs. Refinancing a personal loan can help you improve your loan terms by: 

• Shortening the loan term: By refinancing you can choose to shorten the loan terms which will mean that you pay off your loan faster. With a short loan, you can save money on interest over the life of the loan. For example, if you have a 3-year loan instead of 6 years you can pay off the loan in half of the time. 
• Extending loan term: On the other hand, refinancing can also extend the length of the loan, which will reduce your monthly payment increasing the cash available to you. By increasing your terms you will be able to spread your payment over a longer period which in return will decrease your monthly payment. 
• Changing from an adjustable rate to a fixed rate loan: If you have an adjustable rate refinancing can help you switch to a fixed one. Adjustable rate loans usually will have fluctuating interest rates making it difficult to plan your finances over a long period. 

Overall refinancing your loan can be a smart move to improve your loan terms, reduce your monthly payment and save you money.

Debt Consolidation: Consolidating your debt is a good reason to refinance your loan. Refinancing can allow you to consolidate multiple loans at once such as credit card debt, medical bills, and any other loans into a single loan with one monthly payment. By consolidating your debt you are simplifying your payment and potentially reducing your overall interest on the loans.

This will make it easier to manage your finances as you have one payment to worry about. Also, debt consolidation might save you money on interest, by getting a single loan with a lower interest rate you’re able to pay off your debt faster and save money on interest over time.

However, it is important to understand that debt consolidation loans might not be for everyone because they often require higher credit scores to get the best terms. Overall consolidating your debt can be an effective way to simplify your payment, reduce your interest and pay off your debt faster. 

Improves your credit score: Refinancing a personal loan can potentially improve your credit score. If you make on-time payments on your new loans it will count positively towards your credit accounts, it will show lenders that you are responsible and trustworthy which over time will increase your credit score.

Also when you refinance you reduce your overall debt-to-income ratio (DTI), which is the amount of debt you have compared to your income. If you carry a lot of debt with a low income your DTI will be high which will affect your credit score.

It’s important to understand that refinancing your loan will not be enough to improve your credit score, you need to make sure you make on-time payments on all of your debt and make sure you don’t take on too much debt. 

Disadvantages of refinancing personal loans.

Fees and Costs: While refinancing a personal loan could help you save money in the long run it’s important to be aware that loans do come with fees and costs associated with them. The cost of a personal loan can be the interest, application fee, closing cost, late fees, and prepayment penalties which will increase the cost of the loan. Application fees will be charged by the lender to cover the cost of processing your loan,

Fees can depend on the lender and type of loan your applying for. Closing costs will be fees charged at the end of the loan to transfer the ownership to the borrower, which might include fees like appraisals, title searches, and even attorney fees. Prepayment penalties will be fees charged by the lender if you pay off the loan before the agreed-upon time, this is done by the lender to recoup some of the profit they would have received if they had the loan for the full time.

In addition to some of those fees, there could be other fees associated with refinancing such as the cost of obtaining a credit report and hiring an attorney. All of the costs could add up quickly and it is important to carefully review all the fees associated with the loan before accepting it.

Also, it’s important to shop lenders to see which one might have the least amount of fees or none at all, be sure to negotiate the fees to increase your savings. 

Extended Loan Terms: Refinancing a personal loan can be a great way to reduce your monthly payment, but you should understand the consequence of having a longer loan. By increasing your loan terms you will usually end up paying more interest over the life of the loan.

If you extend your loan you can spread out your payments over a longer period decreasing your payment. While this can free up some funds for you it usually will increase the total loan amount and interest paid over the life of the loan.

For example, if you have $10,000 at 5% with five-year terms and you refinance the same amount but for 7 years with 4% interest. You will end up paying over $1,000 extra in interest.

You should carefully consider the trade-off between lowering your monthly payment and the over cost of doing so. 

Risk of defaulting: While refinancing your loan can reduce your monthly payment, it can also increase the risk of defaulting on the loan. When you refinance a loan you can secure a lower interest rate or even get longer terms, but if you extend the loan you will increase your overall debt.

If you struggling to make your current payment refinancing can provide temporary relief, but it can lead to an overall higher cost of debt which can increase your risk of default. If you’re considering refinancing your loan you should carefully evaluate your financial situation and make sure that you’re able to make payments over the life of the loan.

Also should seek help from a financial advisor to develop a budget and payment plan that works for you. 

Impact on credit score: Refinancing your loan can have a positive impact on your credit score and can also have a negative impact as well. Usually, when you refinance your loan you will get a credit check which will result in a temporary dip in your credit score.

Also refinancing will open a new account which can impact your credit utilization ratio and the length of your credit history which are factors that affect your credit score. Having a credit check will have a temporary drop in your credit score of around five points, usually, the drop is temporary and will reset after some time.

Also opening a new credit account can impact your credit utilization ratio which is the percentage of available credit that you using. If you have a large amount of debt on your credit cards, getting a new account will increase your overall available credit and lower your credit utilization ratio.

On the other hand, having a new loan will lower the average age of the account which will negatively impact your credit score. The length of credit history is a huge factor in determining your credit score.

If you’re considering refinancing your loans it’s important to consider all the options to make an educated decision.