Should You Refinance Your Personal Loan? Benefits, Drawbacks and Steps to Consider

What does refinancing a personal loan mean?

Refinancing a personal loan involves taking out a new loan and using it to pay off an existing personal loan. The new loan may be with your current lender or with a different lender. Borrowers usually consider refinancing because their circumstances, goals or available loan options have changed.

The aim is often to obtain different terms, such as a lower interest rate, a different repayment period, lower regular repayments or loan features that better suit how the borrower wants to manage the debt. However, refinancing is not automatically cheaper or better. Fees, penalties, credit enquiries and the total interest payable over the full loan term all need to be considered.

Common reasons borrowers consider refinancing

People refinance personal loans for different reasons. The right question is not simply whether the new repayment looks lower, but whether the overall arrangement is more appropriate after all costs and conditions are taken into account.

Seeking a lower interest rate

A lower interest rate may reduce the amount of interest charged, depending on the loan balance, fees and repayment term. This is one of the most common reasons borrowers look at refinancing, particularly if their credit position or market options have changed since they first took out the loan.

Changing the repayment term

Refinancing can allow a borrower to choose a different repayment timeline. A shorter term may help repay the debt faster, but could increase regular repayments. A longer term may reduce monthly repayments, but can increase the total interest paid over the life of the loan.

Consolidating multiple debts

Some borrowers use refinancing as part of a debt consolidation strategy, where several debts are combined into one loan. This can make repayments easier to manage because there is one repayment schedule rather than several. Whether it reduces costs depends on the interest rate, fees, term and the debts being consolidated.

Improving cash flow

If a household budget is under pressure, refinancing to a longer term may reduce regular repayments. This can create more breathing room in the short term, but it should be assessed carefully because a longer loan can cost more overall.

Accessing different loan features

A new loan may offer features that the current loan does not, such as more flexible repayments or fewer ongoing fees. These features should be assessed alongside the interest rate and total cost, rather than in isolation.

Potential benefits of refinancing

Refinancing may provide benefits when the new loan terms genuinely improve the borrower's position after costs are included. Key potential advantages include:

• Lower interest costs: A lower rate may reduce interest charges, particularly if the repayment term is not extended unnecessarily.
• More manageable repayments: A different term may make repayments fit more comfortably within a budget.
• A clearer repayment structure: Consolidating multiple debts into one loan can simplify administration.
• Repayment flexibility: Some loans may offer features that better match the borrower's current circumstances.
• Faster debt reduction: A shorter term may help clear the loan sooner if the higher repayment is affordable.

To test the effect of different loan amounts, interest rates and terms, a personal loan repayment calculator can help estimate repayments and compare scenarios before making an application.

Possible drawbacks and costs

The main risk with refinancing is focusing on one attractive feature, such as a lower monthly repayment, without checking the full cost of the new loan. The following issues are worth reviewing before proceeding.

Interest rates are only one part of the comparison. Fees and comparison rates can also affect the overall cost, so it may help to review how personal loan interest rates, comparison rates and fees work before deciding whether refinancing is worthwhile.

How to decide whether refinancing may be suitable

A structured review can help determine whether refinancing is worth further investigation. The following steps are educational in nature and should be adapted to the borrower's own circumstances.

1. Review the current loan. Check the outstanding balance, interest rate, repayment amount, remaining term, fees and any early repayment costs.
2. Clarify the goal. Decide whether the priority is lower repayments, lower total interest, simpler debt management, faster repayment or different features.
3. Compare the total cost. Look beyond the headline rate and compare fees, term length and total repayments over the life of the new loan.
4. Consider credit impacts. Refinancing usually involves a credit enquiry, so unnecessary applications should be avoided.
5. Check whether the benefit outweighs the cost. A lower repayment is not always cheaper if the loan runs for longer or has higher fees.

If you decide to compare personal loan options, consider the full loan structure rather than relying only on the advertised repayment or interest rate.

Steps in the refinancing process

1. Research and compare lenders

Start by reviewing a range of lenders, including banks, credit unions and online lenders. Compare interest rates, fees, repayment terms and flexibility. Customer reviews may also provide general insight into service standards, though they should not replace a careful review of the loan contract.

2. Gather documents

Lenders commonly ask for identification, proof of income and details of the existing loan. Having accurate and up-to-date documents can make the application process more straightforward.

3. Apply for the new loan

The lender will assess the application, including the borrower's financial situation and creditworthiness. Australian lenders may review income, expenses, debts and other information as part of their assessment. For more detail on this process, see this guide to responsible lending checks for personal loans.

4. Pay out the existing loan

If the new loan is approved and accepted, the old loan must be paid out. Depending on the lender, funds may be sent directly to the existing lender or provided to the borrower to settle the balance. It is important to confirm that the previous loan is fully closed and that no outstanding amount remains.

5. Monitor the new loan

After refinancing, keep track of the new repayment schedule, interest rate, fees and any conditions attached to the loan. Ongoing monitoring helps ensure the loan continues to be managed in line with the borrower's budget and repayment goals.

Alternatives to refinancing

Refinancing is not the only way to address loan repayments or debt management. Depending on the situation, one of the following options may be considered instead.

Negotiate with the current lender

Before applying elsewhere, it may be worth asking the current lender whether better terms are available. Some lenders may be willing to review the interest rate, repayment structure or certain fees, although this is not guaranteed.

Consider debt consolidation

Where multiple debts are involved, debt consolidation may be considered. This can simplify repayments, but the terms need to be checked carefully. A consolidation loan with a longer term or higher fees may not reduce the total cost.

Review the budget

Some repayment pressure may be addressed by adjusting spending, setting a clearer budget or redirecting surplus income towards the loan. This will not change the loan contract, but it may improve repayment management.

Increase repayment capacity

Where possible, increasing income or making additional repayments may help reduce the loan balance faster. Borrowers should check whether extra repayments are allowed and whether any fees apply.

Key takeaway

Refinancing a personal loan may help some borrowers obtain different terms, simplify repayments or adjust their repayment timeline. It can also involve fees, credit checks and the risk of paying more over time if the new term is extended.

The decision should be based on the full cost of the existing loan compared with the full cost of the proposed new loan. Reviewing fees, repayment terms, total interest and credit implications can help borrowers make a more informed decision.