Should You Refinance Your Personal Loan?

5 MinsJune 17, 2022

Roshan Mathew, 31, took out a personal loan of Rs 3 lakh in 2021. He got it at an interest rate of 13% per annum for a three-year tenure. It’s been a year now, and he is thinking of refinancing it. Refinancing means paying off an existing loan by taking a new one which offers a better interest rate.

Refinancing Your Personal Loan

This usually happens in three scenarios. The first is when the current EMI (equated monthly instalments) are too high, and the borrower cannot handle the pressure. Second, if the borrower feels that the interest rate is very high or third if the borrower is getting a cheaper loan from another lender.

Refinancing a loan is easy these days, thanks to the number of available options, but Roshan needs to ask himself two questions before deciding.

1. How much does he still owe on his loan?
All loan EMIs are structured so that during the initial period of repayment, every instalment has a higher interest component and a smaller principal component. This is true for about half of the tenure of the loan, after which the interest amount tapers off. As a result, it makes sense to refinance a loan – provided you are getting a lower interest rate – during the first half of the tenure.

However, if you have already serviced the loan for over half its term, the bulk of the interest applicable has been paid off. In that case, it doesn’t make sense to refinance the loan. Doing so will only mean that the borrower will end up paying more interest.

In Roshan’s case, he has availed a personal loan of Rs 3 lakh at 13% for three years. His monthly EMI is Rs 10,108. After 12 months, he has a principal amount outstanding is Rs 2,12,617. This is over 2/3rd the loan amount. It, therefore, makes sense for him to refinance the loan. If the principal to be repaid was less than 20-30%, it wouldn’t have made sense for him.

2. Current interest rate versus new rate?
If Roshan had a good credit score (over 750), he might have qualified for a loan at an interest rate of 10.5%-11%. However, Roshan’s credit score is around 700-mark. It will be tough for him to get a loan at 11%. He might qualify for a personal loan at 12.5%. If he qualifies for a loan at this rate, his EMI will come down to Rs 10,058 a month. His interest savings over 24 months will be Rs 1,200.

If he qualifies for a loan at 11%, his EMI will be Rs 9,910. His interest savings over 24 months will be Rs 4,752, which is a significant amount of money, but it is unlikely that he will qualify for it. 

[Also ReadFive questions to ask before availing of a personal loan]

So what should Roshan do?
Does this mean Roshan should not refinance his loan? When you look at Roshan’s options, he is in a tough spot. His credit score isn’t up to the mark, so he won’t qualify for a lower interest rate.

Roshan needs to figure out if he can pay off his loan in less than a year. If he can pay it off in 12 months at a 12.5% interest rate, his EMI will be Rs 18,941. His interest savings will be Rs 15,311, which is a significant amount. If he chooses a loan tenure of 18 months, his EMI works out to Rs 13,015, and his interest savings will be Rs 8,322.

Axis Bank offers a range of Personal Loans tailored to meet the needs of most borrowers, at competitive interest rates. If you are looking to switch your personal loan, visit the website to know more about Axis Bank’s offerings. You can use Axis Bank’s personal loan EMI calculator to know more.

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