Does Refinancing a Personal Loan Hurt Your Credit?

A personal loan is a solution to a host of planned and unplanned financial needs we come across every day. Whether financing a marriage or meeting a medical emergency, fast cash from a personal loan may come as a great relief. 

But often, it isn't possible to 'shop around' or do adequate research to find the best lender offering the best terms. Mostly this happens when the loan is unplanned and hastily taken to meet an emergent situation. Is there a way to correct any mistakes in such cases later?

Yes - refinancing the existing personal loan by another loan from the same or a different lender at better terms and conditions. 

You might be wondering if it's any good to take a loan to repay another loan without hurting your credit! Here's where it gets good. In this article, we will give you a detailed insight if it is true or a hoax - does refinancing a personal loan hurt your credit?

What Does Refinancing a Personal Loan Mean?

Refinancing a personal loan means replacing the existing loan along with its terms and conditions, with another personal loan. Replacement of one loan with a specific rate of interest or repayment tenor could be done with another personal loan with a potentially more flexible rate of interest or repayment tenor. 

Refinancing is one of the best options when the interest rates of the existing loan are more than the current interest rates. It could also be a great option if the replacement loan has a bigger timeline of repayment compared to the present loan. 

But most people are confused - does refinancing a personal loan hurt your credit? And hence, some of them do not approach this idea. 

Why does Refinancing Your Personal Loan Make Sense?

It always makes sense to refinance a personal loan when it saves money. A likely scenario is the dropping of interest rates. Refinancing the existing personal loan at a lower interest rate means fewer payouts and this translates into savings.

There are other reasons, too, when it works in your favour. Consider the following scenarios:

Wise and Opportunistic Switching Between the Type of Interest rate

Refinancing works for you when your income allows you to pay more towards the new loan payment and finish early by paying less interest

Another scenario is when you borrow at a variable interest rate, hoping to take advantage of rates falling in the future. But it actually made your monthly budgeting difficult, making you unsure of the varying amount of interest payable every month. 

It's prudent to switch to a fixed interest rate, especially when there's a rising trend in interest rates in the market. That will not only save big bucks on interest payouts but will also help you to plan your monthly finance better with a known monthly amount towards loan interest.

Coping Better in Times with Lower Incomes

You have taken a personal loan, planned for its monthly repayment but suddenly you lose your job! Or any other scenario for that matter where your monthly income reduces.

In such cases refinancing may come as a boon. You may get a longer tenor or lower interest rate with the new lender. Either of these reduces the amount you need to pay every month. Though longer tenor may not always be cheaper, it can reduce the monthly bill serving relief.

To Improve Your Credit Score

Your credit score may have gone up since you took that personal loan. So you are pretty eligible to get a new loan to refinance the existing one at a lower interest rate. Refinancing is a wise decision in such a case.

For example, many reputed NBFCs offer balance transfer of an existing home loan which is nothing but generally refinancing at a better rate of interest.

The Need to Avoid a 'Balloon Payment'

Many personal loans come with a feature that calls for a much larger payment near the end of the tenor when compared to your normal monthly payable amount. This is what is called a 'balloon payment.'

A wise way to avoid paying such a considerable amount is to plan and refinance such a loan well ahead of time. 

Being Able to Repay the Loan Faster

A shorter tenor means a lesser payment of interest than a longer one. So why not save some money towards that when your new lender is ready to refinance your existing personal loan with a shorter tenor of repayment?

Better Loan Features

Depending on your past payment history and credit score, the new lender may offer attractive loan features like waiver of last EMI, zero processing fee, top-up facility, etc.

Yes and No. But how and why?

Wherever you go shopping for refinancing, you seek a fresh personal loan. Approaching multiple agencies and lenders you approach for fresh credit, will cause the lending NBFCs and other institutions to closely verify your current credit report.

This close verification is often known as a ‘hard pull.’ A 'hard pull' on your credit report is done to know your worth as a prospective loanee.

A hard pull can even lower your credit score by as much as 10 points. This can be a temporary hazard if you are actually seeking two massive loans at the same time - for example, a car loan or house mortgage simultaneously.  

Multiple credit queries from various lenders into your credit report may portray you as a credit-hungry person, further reducing your credit rating. So it's better to time your refinance correctly and not create a coincident issue with your prospective car loan or house loan.

However, such credit inquiries have a 'short-term' effect on your credit report, and timely repayment of your new (refinanced) loan will improve your credit score over time to where it belonged and even better.

Learning alone the good reasons behind refinancing doesn't minimise your chances of pitfall, and you must know the other side too to better judge your need for refinancing.

An extended tenor with the refinanced loan may lessen my monthly burden of payment instalment, but it definitely amounts to payment of more interest in the long run. It may be construed as postponement of liability and nothing else, though it works in your help keeping you solvent on a monthly basis.

Refinancing and shopping for that will entail hard pull credit queries on behalf of the lenders, which can bring down your credit score detrimentally, although for a short term. Timing of such shopping along with solicitation of other major loans may further hamper this.

Washing your hands off the existing loan does call for some penalties, which might be termed as 'prepayment fees' imposed by your current lender. This is because refinancing actually means paying off your current loan first and starting the new one next. On the other hand, the new lender might charge 'application fee' and 'origination fees.' All these, taken together, must not add to your financial woes. 

After all the research, comparison, and sending applications, it takes time to zero on a particular lender for refinancing. If your existing loan is on the verge of being paid off, efforts on refinancing may not be worthwhile. 

Refinancing is the best option in the beginning years of your loan as the interest burden is at its peak during this time. Hence switching loans at this very time sees you as a clear winner.

Refinancing an existing loan is synonymous with paying a number of fees. Your current lender may charge a 'prepayment fee' when the loan gets closed earlier than its contractual repayment period.

Refinancing a home loan, for example, attracts fees charged toward home appraisal and credit reports.

Over and above that, the new lender may charge you with 'application fees' or ‘origination fees.' The summation of all such fees must not outweigh the benefit of refinancing, which will become 'unprofitable’ in that case. So do your maths before jumping at refinancing a loan.

Conclusion

To sum it up, one thing is for sure: refinancing needs a bit of financial wisdom and thorough research to strike the best trade-off expected out of such an exercise. It also inculcates a habit of realigning your repayment habits to secure back the lost credit score wasted through queries.

Staying creditworthy in the era of living on credits is essential, and the more successful you are in striking a befitting refinance deal, the more creditworthy you are. But remember to keep a tab on your credit report that keeps you updated with your financial health.

Keep yourself updated with the presence of tech-driven players like the moneyview, who understand the Gen Y customers better and offer them the most befitting solutions for personal loans and their refinancing in the most attractive way.  

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