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Maybe you’ve already tried to apply for a regular personal loan — only to be turned down. If so, a guarantor loan might be an option worth looking into. With this type of loan, the guarantor (often a close friend or family member) agrees to repay the loan if the borrower can’t. Since this reduces risk to the lender, guarantor loans can make it possible for those with poor or limited credit to qualify for an unsecured personal loan.

However, guarantor loans come with risks and costs — for both the borrower and the guarantor. Here are some things to consider before you apply for a guarantor loan.

What Is a Loan With a Guarantor

A guarantor loan is typically an unsecured personal loan that requires the primary borrower to have a financial backer, or guarantor. A guarantor may be required because the borrower has not yet established credit or has had credit issues in the past (such as a history of late or missed debt payments). It’s still considered the borrower’s loan, but the guarantor is legally obligated to cover payments and any other fees if the borrower defaults on the agreement.

This guarantee reduces the lender’s risk and enables them to advance the money at a reasonable annual percentage rate (APR). However, APRs for guarantor loans are generally higher than APRs for regular personal loans.

How Do Guarantor Loans Work?

Guarantor loans work in the same way as other types of personal loans — you borrow a lump sum of money from a lender, which you are able to use for virtually any purpose. You then pay it back (plus interest) in monthly installments over a set period of time, which may be anywhere from one and seven years.

The only difference is that a third party (your guarantor) is part of the loan agreement. The guarantor is legally bound to make payments on the loan in the event that you default. A loan default is generally defined as missing payments for several months in a row but the exact meaning will depend on the lender.

While the guarantor bears responsibility for repaying the debt, this individual doesn’t have any legal right to the loaned money or anything purchased with the loan proceeds.

Are You Guaranteed to Get a Loan With a Guarantor?

Although it can certainly help your case, there’s no guarantee that you’ll qualify to take out a loan with a guarantor. Approval depends on the financial profiles of you and your guarantor and the eligibility requirements of the lender.

Who Can Be a Guarantor for Loans?

A guarantor doesn’t need to be anyone specific — it could be a parent, sibling, friend, or even a colleague. You generally want to choose someone you trust and feel comfortable openly discussing your finances with. That’s most likely going to be a family member or a close friend.

Guarantors also need to have a good credit history and typically be at least age 18 (though some lenders require a higher minimum age). Some lenders also require the guarantor to be a homeowner. As part of the application process, guarantors will need to undergo a credit check and provide proof of identification and income, as well as bank details and statements.

What Should I Look for in a Guarantor Loan?

Like any other loan, it’s generally a good idea to look for a guarantor loan with a competitive personal loan interest rates and low or no fees. You’ll also want to carefully consider the monthly payments and be sure you can comfortably afford to make them. While this is crucial with any loan, it’s particularly important with a guarantor loan, since your guarantor will be on the hook for repayment if you fall behind. This could impact your credit as well as put a significant strain on your relationship with your guarantor.

How Much Can I Borrow for a Guarantor Loan?

Many lenders offer personal loan amounts ranging anywhere from $500 to $50,000 (and sometimes up to $100,000 for borrowers with excellent credit). Loan amounts for guarantor loans will depend on which lender you choose as well as your financial situation and your guarantor’s credentials (such as their credit score and income).

Guarantor Loan Requirements

Guarantor loans have eligibility requirements such as minimum credit scores and income thresholds that the guarantor will have to meet. Here’s a closer look.

Credit Score

While the borrower’s credit score might be poor or fair, the guarantor’s credit score should be considerably higher in order to secure the loan.

Proof of Residency

A guarantor will need to provide proof of residency. This can be done by showing documents such as a utility bill, a mortgage or rental agreement, or bank statements.

Income

The guarantor will need to verify a consistent income that’s sufficient to make payments on the loan if the primary borrower cannot. They will need to be able to show proof of income through bank account statements, pay stubs, invoices, and/or tax returns.

Age Requirements

The guarantor must be at least 18 years old, though some lenders have an age requirement of 21 or 22. They will need to show proof of age (and identity) with a government-issued photo ID.

Recommended: How to Apply for a Personal Loan

Types of Guarantors

Guarantors aren’t just for personal loans, and they don’t always take on the full financial responsibility of the agreement they’re entering into. Here’s a look at some different types of guarantors.

Guarantors as Certifiers

A guarantor may act as a certifier for someone looking to land a job or get a passport. These guarantors pledge that they know the applicant and they are who they say they are.

Limited vs Unlimited

Acting as a guarantor doesn’t always mean you’re responsible for the entire loan if the primary borrower fails to repay it. Limited guarantors are liable for only part of the loan or part of the loan’s timeline. Unlimited guarantors, however, are responsible for the full amount and full term of the loan.

Lease Guarantor

A guarantor may be required to cosign an apartment lease if the renter has limited credit and income history. In the event that the tenant is unable to pay the rent or prematurely breaks the lease agreement, the guarantor is responsible for paying any money owed to the landlord.

Guarantors vs Cosigners

Guarantors and cosigners play similar roles in a lending agreement — they pledge their financial responsibility for the debt to strengthen the primary borrower’s application. And, in both cases, these individuals may become responsible for repaying the debt.

However, there are some key differences between a guarantor and a cosigner. The main one is that a cosigner is responsible for repayment of the debt as soon as the agreement is final and will need to cover any missed payments. A guarantor, on the other hand, is only responsible for repayment of the debt if the primary borrower defaults on the loan.

There are also differences in terms of credit impacts. A cosigner will have the loan added to their credit report and any positive or negative payment information that the lender shares with the consumer credit bureaus can have a positive or negative impact on their credit. Becoming a guarantor, on the other hand, will typically not have an impact on an individual’s credit unless the primary borrower defaults on the loan. At that point, the loan will appear as part of the guarantor’s credit report.

Pros and Cons of Guarantor Loans

A guarantor loan can allow you to borrow money even if you have limited or less-than-ideal credit. It can also help you avoid expensive and risky subprime loans that are marketed to borrowers with bad credit. In addition, the proceeds of a guarantor loan can be used for virtually any purpose, including emergency expenses (such as a car repair or medical bill) and lifestyle expenses (like a wedding or home improvement project).

As with all forms of credit, getting a guarantor loan can help you establish or build your credit, provided you manage the debt responsibly and keep up with your payments. Stronger credit can give you access to loans with better rates and terms in the future, without the need for a guarantor.

But these loans also come with some downsides. For one, guarantor loans can be expensive, often with higher APRs than other types of personal loans. Also, you’ll want to make sure you can keep up with the payments. Should you default, you’ll not only be hurting yourself but also the person who signed on as your guarantor.

Another downside is that there are fewer guarantor loans on the market than traditional personal loans. This can lead to less choice of lenders, making it harder to shop around and find a good deal.

What Happens if a Guarantor Cannot Pay?

A guarantor is legally obligated to repay the loan if the primary borrower defaults. If the borrower defaults and the loan is a secured loan, then the guarantor’s home could be at risk if the borrower defaults on the repayments and the guarantor is also unable to pay. This is not the case for unsecured guarantor loans, but the lender will still pursue the guarantor for the repayment of the debt, possibly through the courts.

Alternative Options to a Guarantor Loan

What if you don’t have a trusted person to ask to be your guarantor or you don’t want to ask anyone to take on this responsibility? Here are some alternatives to a guarantor loan that you could consider.

•   Secured credit card: If you have some cash, you could pledge that as collateral on a secured credit card. Responsible use of this type of credit card could help you build your credit history so you can improve your chances of future loan approval. Interest rates on secured credit cards can be higher than regular credit cards, and there may be fees associated with their use.

•   Flex loan: A line of credit that is similar to a credit card, a flex loan can also be used to build credit. Borrowers can use funds up to their credit limit, repay those funds, and borrow them again. Interest rates on flex loans tend to be high, and there may be fees assessed daily or monthly or each time the loan is used.

•   Loan from a friend or family member: Perhaps the person you ask to be a guarantor doesn’t want to take on that responsibility, but they are willing to directly loan you the money. A loan from family or a friend can be an option to consider, but you’ll want to be sure to have a written agreement outlining the expectations and responsibilities of both parties. This will go a long way to minimizing miscommunication and hurt feelings. Keep in mind that this is not an option that will help you build your credit history.

The Takeaway

Getting approved for an unsecured personal loan is more likely if you have a solid credit history, an above-average credit score, and sufficient income to satisfy a lender’s qualification requirements. If you’re lacking one or more of these things, you might consider other types of loans, which might include a guarantor loan. SoFi does not currently offer guarantor loans.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

What are guarantor loans?

A guarantor loan is typically a type of personal loan that requires the primary borrower to have a financial backer, or guarantor. The guarantor agrees to pay the debt if the primary borrower defaults on the loan agreement.

How do I get a guarantor for a loan?

You might consider asking a trusted friend or family member to be a guarantor. This person should be someone who has solid credit and sufficient income to cover the loan payments should you default on the loan.

Are you guaranteed to get a loan with a guarantor?

No. Having a guarantor may strengthen a loan application, but it’s up to each individual lender to assess the qualifications of both parties.

Photo credit: iStock/fizkes

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOPL-Q425-035

Adding either a guarantor or cosigner to a loan can increase your odds of approval. But while these supportive roles are similar, they are not exactly the same.

Both a guarantor and a cosigner agree to cover a borrower’s debt if the borrower fails to repay what they owe. The key difference is that a cosigner is responsible for the loan right away, whereas a guarantor isn’t responsible for repayment unless the borrower fully defaults on the loan.

Whether you’re looking for a cosigner or guarantor, or thinking of acting as one or the other, there are some key differences both parties need to understand. Here’s a closer look at guarantors versus cosigners.

Is a Guarantor the Same Thing as a Cosigner?

The short answer: No.

Guarantors and cosigners fulfill similar roles: They help make it possible for a primary applicant with poor or limited credit to be approved for a loan by agreeing to take responsibility for the loan should the primary borrower become unable to pay. (These terms can also come into play when someone without a strong credit or income history is looking to rent an apartment.)

But there are some key differences between a guarantor and a cosigner. The biggest is how soon each individual becomes responsible for the borrower’s debt. A cosigner is responsible for every payment that a borrower misses. A guarantor, on the other hand, only assumes responsibility if the borrower falls into default on the loan.

Acting as cosigner versus a guarantor also impacts your credit in different ways. In addition, which role you take on affects how much access you have to information about the loan.

What Is a Guarantor?

A loan guarantor is someone who promises to pay a borrower’s debt if the borrower defaults on their loan obligation. This reduces the lender’s risk and, as a result, they might offer guarantor loans to applicants who wouldn’t qualify on their own.

Unlike a cosigner, a guarantor isn’t responsible for every payment that a borrower misses. They only need to step up when the primary borrower has defaulted on the loan. A default means a borrower has failed to repay the funds according to the initial agreement. With most consumer loans, this typically involves missing multiple payments for several weeks or months in a row.

Simply becoming a guarantor will generally not impact your credit reports and credit scores. But if the loan falls into default, leaving you responsible for all outstanding payments, it will be added to your credit report. If you fail to repay the money owed, your credit rating could be negatively impacted.

Being a guarantor for a rental property is similar to being a guarantor on a loan — it involves you vouching for the tenant. If the tenant is unable to meet their obligations under the tenancy agreement, you (the guarantor) will be legally bound to cover the overdue rent or any damage to the property.

As a guarantor, you have the responsibility of repaying the debt, but you don’t have any legal right to the loaned money, anything purchased with the loan proceeds, or to live in the dwelling if you’re acting as a guarantor on a lease.

What Is a Cosigner?

A cosigner is someone who applies for a loan with someone who may not qualify on their own and takes equal responsibility for the account. For example, many parents act as cosigners on their children’s student loans, since young people tend not to have long and robust credit histories.

Unlike a guarantor, a cosigner’s liability begins right away. Cosigners are responsible for any payments that the borrower misses. If the borrower defaults, the cosigner is also responsible for the full amount of the loan.

The debt account and payment history will appear on both the primary borrower’s credit report, as well as the cosigner’s credit report. And, depending on how the primary borrower manages the account, the loan could help or hurt both the primary borrower’s and the cosigner’s credit scores.

If the primary borrower defaults on the loan, lenders and collections agencies can try to collect the debt directly from the cosigner.

Although the cosigner is legally obligated to make payments if the borrower can’t, they have no rights to the loan proceeds.

A cosigner is not the same thing as a co-borrower in that they don’t have any claim on the loaned asset. Also, unlike a co-borrower, a cosigner’s intention is to boost the creditworthiness of the borrower, not to jointly repay the debt.

Recommended: Getting a $15,000 Personal Loan With Good or Bad Credit

Guarantor vs Cosigner: The Similarities

Both guarantors and cosigners pledge their financial responsibility for the debt to strengthen the primary borrower’s application. And, in both cases, they may become responsible for repaying the debt.

Another thing guarantors and cosigners have in common is that they do not have any right to the loaned money, or assets purchased with the money (one exception: the cosigner on a lease may be entitled to live on-site).

Guarantor vs Cosigner: The Differences

The main difference between a guarantor and a cosigner is the level of legal liability for the debt.

A cosigner is responsible for repayment of the debt as soon as the agreement is final and can request to have loan statements sent to them, so they’ll know right away if any payments have been missed. A guarantor, by contrast, is only responsible for repayment of the debt if the primary borrower defaults on the loan and will only be notified at that point.

There are also differences in terms of credit impacts. A cosigner will have the loan added to their credit report and any positive or negative payment information that the lender shares with the consumer credit bureaus can have a positive or negative impact on their credit. Becoming a guarantor, on the other hand, will not have an impact on your credit unless the primary borrower defaults on the loan.

Recommended: Guide to Unsecured Personal Loans

Personal Guarantor vs Cosigner: Pros and Cons

If you are the primary borrower and deciding between a guarantor and cosigner, the choice may come down to which kinds of loans are available (guarantor loans can be harder to find than loans allowing a cosigner) and what kind of agreement you’re entering into. If you’re signing a lease with a roommate, that person should be a cosigner rather than a guarantor.

If you’re thinking of acting as a guarantor versus a cosigner, here’s a look at the benefits and drawbacks of each.

Pros and Cons of Being a Guarantor

Pros:

•   Helps a borrower obtain a loan more easily

•   Can help a borrower get approved for a larger loan amount or more favorable rates and terms than they would be able to get on their own

•   Helps a borrower build credit and learn how to manage credit responsibly

Cons:

•   Your credit score could be impacted if the borrower defaults on the loan

•   You’ll be liable for the full debt if the borrower defaults on the loan

•   Should the borrower default, your ability to obtain another loan for a different use may be limited

Pros and Cons of Being a Cosigner

Pros:

•   Helps a borrower obtain a loan more easily

•   Can help a borrower get approved for a larger loan amount or more favorable rates and terms than they would be able to get on their own.

•   Helps a borrower build credit and learn how to manage credit responsibly

Cons:

•   Your credit could take a hit if the borrower pays late or misses payments and the lender reports the delinquency to the credit bureaus

•   You will need to make any payments the primarily borrower misses

•   If need to apply for credit for yourself, the lender may deny you because your current debt levels are too high

Recommended: How Do I Get the Best Interest Rate on a Loan?

Do Guarantors Get Credit Checked?

Yes — as part of the application process, the lender will carry out a credit check on you. However, this is normally a “soft” credit check which will not be visible to other companies and won’t impact your credit score. Generally, a guarantor will need a robust credit and income history to make up for the applicant’s shortcomings.

When Is a Cosigner or a Guarantor a Good Option?

Recruiting a cosigner or guarantor can be a good option if you have low credit scores or a limited credit history and are looking to get a personal loan, student loan, mortgage, auto loan, or other type of credit. This can not only help you qualify for the loan but also give you access to better rates and terms than you could get on your own.

Taking out a loan with a guarantor or cosigner — and making regular on-time payments on that loan — can help you build your credit. This can help you qualify for more types of loans and better rates in the future without a cosigner or guarantor.

Just keep in mind that if you ask a trusted friend or family member to act as a cosigner or guarantor and you fail to make timely payments, you could put a significant strain on your relationship. You will also be putting that person in a difficult financial position.

Questions to Ask a Guarantor or Cosigner

One of the weightiest parts of deciding to use a cosigner or guarantor is having to ask someone to do you this favor, which is a big one. It’s important that there’s mutual trust in the relationship between the borrower and cosigner or guarantor, since their actions can have an impact on each other’s finances.

Some questions to ask your cosigner or guarantor before entering an agreement include:

•   Do you have a good credit score and solid financial standing?

•   Are you willing to take on this legal and financial responsibility?

•   What will our long-term agreement be if I, as the primary borrower, fail to make repayments and force you into the legal obligation to do so?

Personal Loans That Allow You to Use a Cosigner or Guarantor

Not all lending institutions allow you to apply for a personal loan with a cosigner or a guarantor. Some only allow co-borrowers. If you aren’t able to qualify based on your own creditworthiness, you may consider asking the lender if they’ll allow a cosigner or guarantor.

Getting a personal loan with a cosigner or guarantor can make it much easier to qualify for a loan because, in the eyes of the lender, a second person agreeing to take on responsibility for the loan lessens the risk of lending to you.

The Takeaway

Guarantors and cosigners fulfill similar roles for a loan applicant, strengthening the application by taking on some level of financial responsibility for the loan.

A cosigner takes on responsibility for your payments right away, while a guarantor won’t get involved in the loan unless you end up missing several payments and are considered in loan default.

Either option could help you qualify for a personal loan with lower interest rates and better terms than you might be able to get on your own. Note: SoFi does not currently offer personal loans with guarantors.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

Does being a guarantor affect your credit?

Yes, being a guarantor can impact your credit. It can have a negative effect on your credit if the borrower misses payments. It can also affect your ability to secure future loans since it increases your debt-to-income ratio.

What are the disadvantages of being a guarantor?

Being a guarantor can add to your debt-to-income ratio, which can lower your credit. Also, if the borrower defaults, you are liable for the loan, and your credit can also be negatively impacted.

Are guarantors and cosigners the same thing?

Both guarantors and cosigners are responsible for a loan along with the other person who took out the funds, but a guarantor is only liable if the primary borrower defaults. A cosigner is responsible right away.

Photo credit: iStock/FreshSplash

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOPL-Q425-031

If you’re looking to start or grow a side hustle or small business, you might think a business loan is the right next step. A personal loan, however, is another popular financial product that you also might be able to use. For instance, by using it to free up some cash elsewhere in your budget, you could put more of your income toward funding your business.

Because there are potential benefits and disadvantages to both types of financing, it’s important to understand the differences. You’ll find that information here and be better equipped to decide whether a business loan vs. personal loan might work best for you.

What Is a Personal Loan?

A personal loan is a source of financing that a borrower typically can use for just about any legal personal purpose. That said, you typically cannot use the money from a personal loan directly for your business. You might instead use the lump sum to consolidate credit card debt, which could free up funds in your overall budget to put back into your business.

Typically, you’ll find unsecured personal loans, with the borrower agreeing to pay back the full amount, plus interest, in fixed monthly payments within a predetermined time frame.

Some lenders also offer secured personal loans, however,which means some form of collateral is involved. Also, some offer personal loans with variable interest rates.

How Personal Loans Work

When you apply for a personal loan, you can expect the lender to review your personal financial information — including your credit score, credit reports, and income — to determine your eligibility. In general, the better your credit, the better your chances of receiving a lower interest rate.

Personal loan amounts vary, but some lenders offer personal loans for as much as $100,000.

Although most personal loans have shorter repayment terms, the length of a loan can vary from a few months to several years. Typically, they last from 12 to 84 months.

What is a Business Loan?

A business loan is a type of financing used specifically to pay for business expenses. It could be used to purchase equipment or inventory, for example, or to fund a new project.

There are many kinds of small business loans available — with different rates and repayment terms — including Small Business Administration (SBA) loans, equipment loans, micro loans, and more. Rates, terms, and loan requirements also can vary significantly depending on the lender.

How Business Loans Work

Applying for a business loan tends to be more complicated than getting a personal loan. For one thing, you’ll likely have to submit more paperwork to back up your application, including your business’s financial statements and an up-to-date business plan. The lender also usually will want to review your personal and business credit scores. And you may have to be more specific about what the loan will be used for than you would with a personal loan.

If your business is brand new, lenders may be reluctant to give you a business loan. Some lenders might ask you to put up some type of collateral to qualify.

Differences Between Business and Personal Loans

There are several factors you’ll want to understand when considering the difference between a personal loan vs. a business loan, including the loan costs, how you plan to use the money, and how much you hope to borrow. Here’s a look at a few basic differences.

Cost Differences Between Business and Personal Loans

Whether you’re considering applying for a business loan or a personal loan, it’s important to be clear about how much it could cost you upfront and over the life of the loan.

Interest Rates

Interest rates for business loans can be lower than for the interest rates for personal loans, but the rates for both can vary depending on the type of loan, the lender you choose, and your qualifications as a borrower.

Fees

Fees also can affect the upfront and overall cost of both personal and business loans, so it’s a good idea to be clear on what you’re paying. Some of the more common fees for business loans and personal loans that you might see include origination, application, packaging, and underwriting fees, and late payment and prepayment penalties.

Some fees may be subtracted from the loan amount before the borrower receives the money. But fees also may be folded into a loan’s annual percentage rate (APR) instead, which can increase the monthly payment.

Down Payment

Business loans may be available for larger amounts than a personal loan. For a larger business loan — a substantial SBA loan or commercial real estate loan, for example — you could be required to come up with a down payment. This amount can add to your upfront cost. However, just as with a mortgage or car loan, a larger down payment can help you save money over the long term, because you’ll pay less in interest.

Whether you’ll need a down payment, and the amount required, may depend on your individual and business creditworthiness.

Different Uses for Business and Personal Loans

One of the biggest differences between business vs. personal loans is the way borrowers can use them.

•   A business loan can be used to finance direct business costs, such as paying for supplies, marketing, a new piece of equipment, business debt consolidation, or a business property. But it typically can’t be used for indirect business costs, which means a borrower can’t pay off personal debts with the money or buy personal property with it.

•   Some business loans have a very specific purpose, and the borrowed money must be used for that purpose. For example, if you get an equipment loan, you must buy equipment with it. Or, if you get a business car loan, you must buy a business car with the money.

•   With a personal loan, you have tremendous flexibility in how you use the loan, although that usually does not include business purposes. Rather, you can use a loan to pay off credit card debt, fund a home improvement, or pay an unexpected medical or car repair bill. Personal loans are typically smaller than business loans, and they generally come with a shorter repayment term. It can be helpful to have a clear intent for how the money will be spent and to keep separate records for business and personal expenses.

Differences When Applying for Business and Personal Loans

The criteria lenders look at can be very different when approving a small business loan vs. a personal loan. Here’s what you can expect during the application process.

Applying for a Personal Loan

When you apply for a personal loan, your personal creditworthiness usually plays a large role in the application and approval process.

•   Lenders typically will review a borrower’s credit scores, credit reports, and income when determining the interest rate, loan amount, and repayment term of a personal loan.

•   Generally, you can expect to be asked for a government-issued photo ID, your Social Security number, and/or some other proof of identity.

•   You also may be asked for proof of your current address. And the lender will want to verify your income.

Applying for a Business Loan

When you apply for a business loan, your personal finances still will be a factor, though other aspects of your application will be reviewed carefully.

•   The loan underwriters also will evaluate your business’s cash flow, how long you’ve been in business, your profitability, the exact purpose of the loan, trends in your industry, your business credit score, and more.

•   The lender may ask for a current profit-and-loss statement, a cash-flow statement, recent bank statements and tax returns for the business, your business license and a business plan, and any other current loan documents or lease agreements you might have.

•   You also will have to provide information about your collateral if you are applying for a secured loan.

Recommended: Understanding Credit Score Ranges

Structural Differences in Business and Personal Loans

Knowing the differences in how personal loans vs. business loans are structured could help you decide which is right for you and your business. A few factors that might affect your choice include:

Loan Amount

A business loan may be more difficult to apply for and get than a personal loan, especially if your business is a startup or only a few years old. But if you can qualify, you may be able to borrow more money with a business loan. While personal loan amounts typically top out at $50,000 to $100,000, some SBA loans can go as high as $5.5 million.

Loan Length

You’ll likely find personal and business loans with both short and long repayment terms. But generally, personal loans have shorter terms (typically one to seven years), while some business loan repayment periods can be up to 25 years.

Tax Advantages

If you have a business loan, deducting the interest you pay on the loan may be possible when filing income taxes if you meet specific criteria.

With a personal loan, it might get a little more complicated. If you use the borrowed money only for business costs, you may be able to deduct the interest you paid. But if you use the loan for both business and personal expenses, you would only be able to deduct the percentage of the interest that was used for qualifying business costs.

And you should be prepared to itemize deductions, documenting exactly how you spent the money. Your financial advisor or tax preparer can help you determine what’s appropriate.

Support

Along with the traditional banking services you might expect to get with any type of loan, a business loan also may come with operational support and online tools that can be useful for owners and entrepreneurs.

Risk

When you’re deciding between a personal vs. business loan, it’s also a good idea to think about what could happen if, at some point, the loan can’t be repaid.

•   If your business defaults and it’s a business loan, the impact to your personal credit would depend on how the loan is set up.

◦   If you’re listed as a sole proprietor or signed a personal guarantee, it’s possible you could be sued, your personal and/or business credit scores could take a hit, and your personal and business assets could be at risk.

◦   If your business is set up as a distinct legal entity, on the other hand, your personal credit score might not be affected — but your business credit score could suffer. And it could be more difficult for you to take out a business loan in the future.

Pros and Cons of Business Loans

There are advantages and disadvantages to keep in mind when deciding whether to apply for a business loan vs. personal loan.

•   A business loan can be more difficult to get than a personal loan, especially if the business is new or still struggling to become profitable.

•   If you qualify for a business loan, you may be able to borrow a larger amount of money and get a longer repayment term.

•   A business loan also can make it easier to separate your business and personal finances. {Personal loans typically can only be used for personal expenses, as the name indicates.)

•   There could be fewer personal consequences if the business defaults on the loan.

Recommended: Can You Refinance a Personal Loan?

Pros and Cons of Personal Loans

A personal loan vs. business loan can have advantages and disadvantages to consider.

•   Personal loans can offer borrowers more flexibility than business loans in terms of usage, though those uses must typically be for personal expenses, such as paying for a home renovation or a vacation.

•   They’re generally easier to qualify for and may have lower interest rates.

•   One major hurdle may be that you cannot use them for any business expense in most situations. You could use them to free up cash in your budget which you might then apply to a business purpose.

Is a Business or Personal Loan Right for You?

Considering the differences between a personal loan and a business loan can help you decide which is right for your needs. You may want to do some online research, compare rates and terms, and/or ask a financial professional or business mentor for advice before moving forward with this important decision. Here are some things to think about as you look for a loan that’s a good fit for your personal and professional goals.

A business loan may make sense if:

•   You’re seeking a lower interest rate and/or repayment term.

•   You want to keep personal and business expenditures separate.

•   You’ve been successfully running your business for a while.

•   You need more money than you can get with a personal loan.

•   You hope to build your business credit.

•   You want to limit your liability.

A personal loan may make sense if:

•   Your goal is to use the money for personal purposes, which might free up funds in your budget for business expenses.

•   You plan to use the money for both business and personal expenses.

•   You can find a personal loan with a lower interest rate than a comparable business loan, and the lender approves the loan for business expenses.

•   You want to get the money as quickly as possible.

•   You are seeking a shorter repayment term.

•   You don’t want to secure the loan with collateral.

•   You feel confident about your personal ability to repay the loan.

Recommended: Can I Pay Off a Personal Loan Early?

The Takeaway

If you’re seeking funding to start or grow your business, you may decide to apply for a business loan. Another approach: You might apply for a personal loan, which could be used for personal purposes, freeing up money in your budget that could go toward your business. Personal loans are typically easier to apply for and offer quicker access to funds, but often at a somewhat higher interest rate and shorter term vs. business loans. Also, business loans usually offer significantly higher loan amounts and the interest can be tax-deductible. It’s worthwhile to consider the tax and credit implications of each type of loan too, among other factors.

FAQ

Are business loans more expensive than personal loans?

Business loans typically have lower interest rates than personal loans. However, these two loans aren’t interchangeable: one is for business uses, the other for personal expenses.

Can I use a personal loan for business?

Most (but not necessarily all) personal loans can be used for just about any personal use. Check the fine print, and follow the lender’s guidelines.

Are startup loans personal loans?

There are a few different options for funding a startup, including SBA loans, family loans, or crowdfunding platforms. But if you have good credit and are confident you can make the monthly payments, taking out a personal loan could be an effective strategy for funding a startup, if the loan permits that usage.

Photo credit: iStock/MicroStockHub

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOPL-Q425-040

Beyond making purchases more convenient, credit cards can provide a number of additional and valuable layers of protections. For instance, they can help cover you if you are traveling abroad, buying something pricey or if you were to lose your job or otherwise become unable to pay your bills. Some credit card protections, like travel insurance, are perks of the card included in the annual fee. For others, like credit card payment protection, you may have to opt in and pay an additional fee.

Read on to learn more about the types of credit card protection that are available, how they work, and when they may be worth it.

What Is Credit Card Protection?

Credit cards may offer various forms of protection in their perks and benefits. These protections can help protect your purchases and ensure you don’t pay for charges that aren’t yours.

They can also help you in a dispute with a vendor. For example, if you ordered an item that never made it to you and the merchant won’t give you a refund, you could invoke a credit card chargeback with your credit card company.

Perhaps the most common form of protection associated with the term “credit card protection” is credit card payment protection insurance. This is an insurance plan that you can opt into for a monthly fee that would offer protection if something were to happen that prevented you from paying your bills.

Recommended: Charge Cards Advantages and Disadvantages

Types of Credit Card Protection

Read on for more details on the various forms of credit card protection.

Fraud Protection

One basic benefit of a credit card is typically fraud protection, and this can be why people use credit cards over debit cards or cash. If someone were to steal your credit card number or your physical card, fraud protection shields you from being responsible or liable for charges.

Under the Fair Credit Billing Act (FCBA), creditors cannot “take actions that adversely affect the consumer’s credit standing until an investigation is completed.” This means that all credit card companies will launch an investigation if fraud occurs. During this time, you will not be held liable for the charge in question (though make sure to make your credit card minimum payment so you don’t incur late fees or ding to your credit during the investigation).

Some credit card companies may go beyond that and offer even more fraud protection, including $0 liability. (The FCBA caps liability in case of fraud at $50 if the thief presents the card. The liability is $0 if the card is not physically present, as in the case of someone stealing a credit card number and using it online).

While fraud protection can offer peace of mind, it’s also important to be proactive about recognizing fraud. If you lose your credit card, call your issuer to have the card frozen. And always let your issuer know ASAP if you notice a charge that isn’t yours.

Return Protection

Return protection is another form of purchase protection offered by some credit cards. It allows you to return an item for a set period of time defined in your membership agreement. This return window may offer more leeway than that of the merchant you made the purchase from (for example, 90 days instead of 30 days.)

There may be exclusions to what can and can’t be returned. Further, there also may be a cap on the cost of the item being returned, as well as an annual cap per card, though it depends on how your credit card works specifically.

Price Protection

Have you ever bought something, only to see the item go on sale a week later? That’s where credit card price protection comes in. With this perk, you may be able to receive a refund for the difference in price if you purchased the item with your card.

Generally, it’s your responsibility to track price drops. And your issuer may have certain terms, such as limiting the protection to price drops within a set time period. Price protection also may exclude certain types of purchases, such as tickets to sporting events or concerts.

Purchase Protection

Similar to return protection, purchase protection can help protect you if purchases are lost or damaged or if services aren’t rendered or delivered as expected. Generally, you would bring the issue up with the merchant or service provider. But if they don’t initiate a refund, then you can dispute the charge with your credit card company. This process initiates what’s called a credit card chargeback.

There may be limitations and exceptions to purchase protection. It can be a good idea to talk directly with the merchant before reaching out to your credit card company.

Travel Insurance

Travel insurance can be a big reason to put a trip on a credit card. In fact, some card issuers offer insurance as a perk for using the card.

The specifics of credit card travel insurance depend on the card issuer, but it may include insurance for lost luggage or coverage for trip interruption or cancellation. In general, these insurance policies may not be as comprehensive as a standalone policy, but they can provide some peace of mind when planning a trip.

Car Rental Insurance

Car rental insurance is another type of insurance offered as a credit card perk. If you rent a car with the credit card, the card may provide insurance protection in case of damage. Generally, this includes collision/loss damage waiver coverage.

Car rental insurance through your credit card may allow you to forego the (sometimes pricey) insurance options offered by the car rental agency. However, as with any insurance policy, it’s a good idea to read the fine print to know exactly what is and is not covered.

How Credit Card Protection Works

Most protections are part of the overall perks and benefits of the card. But credit card payment protection is a little bit different. It’s generally an opt-in program that offers protection if you are no longer able to pay your credit card bill. The protection offered can be short term, such as for a life event like a change in employment, or long term, extending for 12 to 24 months in the event of a job loss or hospital stay.

Usually, credit card payment protection carries an additional monthly fee. Also note that payment protection doesn’t let you off the hook from paying the bill down the road. Rather, for a set period of time, your credit card issuer would offer a break on making payments or lower your minimum payments due, as well as pause any fees. Your issuer will continue to report your account in good standing during that time.

Tips to Keep Your Credit Card Safe

Protection programs can give you peace of mind. But losing a credit card or dealing with fraudulent activity can be stressful regardless of what protections you have in place. It can also potentially open the door to identity theft, which could potentially harm your credit.

That’s why it’s smart to set up some smart security behaviors. Read on for some tips for how to keep your credit card safe.

Practice Credit Card Protection From Day One

When you’ve applied for a credit card, keep an eye out for the card to arrive in the mail. It should come in between five and 14 days; your issuer may provide a timeline.

If you don’t receive your card within that time period, call your issuer. They will issue you a new one. And as soon as you do get your card, follow the steps to set it up for use.

Keep Your Account Number Private

Don’t write down your credit card account number, expiration date, and CVV. Don’t share this information with anyone else. Also consider whether or not you want to save payment information online. While it can be convenient, it could leave your information vulnerable. If you are using your credit card to make a payment, make sure that you are doing so through an encrypted service.

Keep Your Information Current

Make sure that the email address, mailing address, and telephone number on file with your credit card issuer are up to date. By doing so, you will be aware of any communication between you and your card issuer. Further, this will prevent a new card from being delivered to the wrong address.

Be Careful With Your Receipts

While federal law prohibits how much credit card information is on receipts, this may not be true in other countries. If you’re traveling abroad, it may make sense to be even more mindful about how you dispose of receipts. Don’t leave them lying around.

Secure Your Devices and Networks

Being mindful of how and when you use your credit card online can help you avoid fraud. Using your own network, rather than public wifi, can be one security step. It can also be helpful to check that a website uses encryption for payment and that it’s a secure site.

Protect Yourself Online

When you’re using a credit card for payment, it’s important to be cyber-savvy. Credit card scams to try to obtain your information or your credit card number are not uncommon.

You’ll want to be on the lookout for phishing attempts. If a merchant or bank asks you to email your credit card number, call the merchant directly. Know that banks will never ask for sensitive information over email. Also be on the lookout for requests to “verify” your information via email or text. Again, these may well be scams designed to get your account information.

Additionally, pay attention to any odd links, misspellings (such as Citii for Citi), or emails that include a link. Instead of following the link within the email, consider manually typing in the URL of a website.

Check Your Account Often

It can be good to get in the habit of regularly checking your credit card balance. Doing so a few times a week, instead of just waiting for a statement to come out, can alert you to fraud as soon as it happens. And remember, a fraudster could steal your information even if your physical card has always been in your possession.

Report Lost Cards and Fraudulent Activity Right Away

If you see something odd on your credit card balance, let your card issuer know right away. The same goes if you can’t find your credit card.

Even if you’re 99% sure your card is somewhere in your house or car, it can be a wise idea to contact your card issuer. In some cases, they can freeze your card. This means that you’ll be able to unfreeze it once you’ve found it, without getting a new card and a new card number.

Recommended: When Are Credit Card Payments Due?

What Does Credit Card Payment Protection Cover?

In general, credit card payment protection insurance has restrictions regarding when it applies, and it may require documentation.

Some reasons you may be able to request long-term credit card payment protection may include:

•   Job loss

•   Disability

•   Hospitalization

•   Death of a child, spouse, or domestic partner

•   Leave of absence (for family or child care, or for military duty)

•   Federal or state disaster

Meanwhile, you may be able to get short-term protection for the following reasons:

•   Marriage

•   Divorce

•   Graduation

•   Childbirth

•   Adoption

•   Retirement

•   New job

•   A move to a new residence

Situations that may not qualify for payment protection include incarceration or voluntarily leaving your job, such as to pursue higher education.

Pros and Cons of Payment Protection

Whether payment protection is right for you depends on some variables. The opt-in program usually costs an additional fee. Plus, while paying your full balance each month is ideal, you could potentially pay the credit card minimum payment if you were going through hard times to keep your account in good standing, though your annual percentage rate (APR) would still apply.

In many cases, it may make sense to focus on bringing down your balance so your minimum payment is relatively low. That way, if the worst were to happen, you might still have enough room in your budget to manage minimum payments.

Is Credit Card Payment Protection Worth It?

Weighing the pros and cons of credit card payment can help you assess whether it makes sense for you. If you carry a very high balance and are in the process of paying it down, payment protection may give you peace of mind — especially if you don’t have a good APR for a credit card. But keep in mind that you could potentially switch to minimum payments during a hard time and still maintain your payment history.

To decide if credit card payment protection is right for you, it’s important to read the fine print and assess how these credit card fees would impact your overall financial outlook. Also take into consideration your current financial situation, your savings account balance, and the general stability and security of your job and lifestyle.

Credit Card Protection Scams and How to Avoid Them

As credit cards offer protection, scammers see opportunities — and these can be tailored, beyond just credit card skimming. There are several credit card protection scams that may target card holders, including:

•   Phone scams offering loss protection for a fee. Some scammers have been calling people and telling them they may be liable for charges beyond $50 on their credit card. They then try to get people to buy loss protection and insurance programs. If you get this call, know that credit cards include fraud protection at no additional fee — plus, your liability is limited to $50 by law. Call your credit card company if you have any questions about its fraud protection programs.

•   Scams claiming your account has been compromised. In this case, the scammer will ask you to provide personal details, such as your credit card number, claiming your account has been compromised. Don’t ever give sensitive credit information over text or via email. If someone calls claiming to be your credit card company, call the company directly from the number on the back of the card. Scammers can mask their true phone number and make it appear as if they are legit.

•   Fraudulent text alerts. Scammers also may send text messages asking for your CVV number on a credit card to “fix” a security problem or “verify” or “update” your account. A real credit card company would never ask for this information nor send text messages like this.

•   Fake account protection offers. Any account protection should come directly from your credit card company, not from a third party. If you receive these offers, don’t take them up on it.

The Takeaway

Credit card protection can be one of the great benefits of using a credit card. While some credit card protections are standard, including fraud protection, it can be helpful to consider what protection offers are most important to you before paying for additional services.

Looking for a new credit card? Consider credit card options that can make your money work for you. See if you're prequalified for a SoFi Credit Card.

FAQ

Are there limits to credit card payment protection?

There may be limits on what qualifies for credit card payment protection, and your issuer may need to see proof of hardship. Further, there may be a time limit on how long credit card payment protection is offered.

Is there a time limit on credit card payment protection?

Generally, issuers have a time limit for credit card protection policies. These vary between issuers, but may be as short as several months or as long as two years, depending on the circumstances.

Should I get credit card payment protection insurance?

Credit card protection insurance may incur an additional fee, unlike other protection options offered as part of your overall perks and benefits within your card. That fee can add to your balance. If your credit card balance is at or near $0, credit card payment protection insurance may not be necessary.

Photo credit: iStock/9dreamstudio

SoFi Credit Cards are issued by SoFi Bank, N.A. pursuant to license by Mastercard® International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOCC-Q425-009

Both a loan modification and a loan refinance can lower your monthly payments and help you save money. Depending on your circumstances, one strategy will make more sense than the other. A modification alters the terms of your current loan and can help you avoid default or foreclosure. Refinancing, on the other hand, involves taking out a new loan (ideally with better rates and terms) and using it to pay off your existing loan.

Here’s a closer look at loan modification vs. refinance, how each lending option works, and when to choose one or the other.

What Is a Loan Modification?

A loan modification changes the terms of a loan to make the monthly payments more affordable. It’s a strategy that most commonly comes into play with mortgages. A home loan modification is a change in the way the home mortgage loan is structured, primarily to provide some financial relief for struggling homeowners.

Unlike refinancing a mortgage, which pays off the current home loan and replaces it with a new one, a loan modification changes the terms and conditions of the current home loan. These changes might include:

•   A new repayment timetable. A loan modification may extend the term of the loan, allowing the borrower to have more time to pay off the loan.

•   A lower interest rate. Loan modifications may allow borrowers to lower the interest rates on an existing loan. A lower interest rate can reduce a borrower’s monthly payment.

•   Switching from an adjustable rate to a fixed rate. If you currently have an adjustable-rate loan, a loan modification might allow you to change it to a fixed-rate loan. A fixed-rate loan may be easier to manage, since it offers consistent monthly payments over the life of the loan.

A loan modification can be hard to qualify for, as lenders are under no obligation to change the terms and conditions of a loan, even if the borrower is behind on payments. A lender will typically request documents to show financial hardship, such as hardship letters, bank statements, tax returns, and proof of income.

While loan modifications are most common for secured loans, like home mortgages, it may also be possible to get modifications for unsecured loans as well, such as student loans and even personal loans.

What Is Refinancing a Loan?

A loan refinance doesn’t just restructure the terms of an existing loan — it replaces the current loan with a new loan that typically has a different interest rate, a longer or shorter term, or both. You’ll need to apply for a new loan, typically with a new lender. Once approved, you use the new loan to pay off the old loan. Moving forward, you only make payments on the new loan.

Refinancing a loan can make sense if you can:

•   Qualify for a lower interest rate. The classic reason to refi any type of loan is to lower your interest rate. With home loans, however, you’ll want to consider fees and closing costs involved in a mortgage refinance, since they can eat into any savings you might get with the lower rate.

•   Extend the repayment terms. Having a longer period of time to pay off a loan generally lowers the monthly payment and can relieve a borrower’s financial stress. Just keep in mind that extending the term of a loan generally increases the amount of interest you pay, increasing the total cost of the loan.

•   Shorten the loan repayment time. While refinancing a loan to a shorter repayment term may increase the monthly loan payments, it can reduce the overall cost of the loan by allowing you to pay off the debt faster. This can result in significant cost savings.

Recommended: How Does a Personal Loan Work?

Refinance vs Loan Modification: Pros and Cons

Loan refinance is typically something a borrower chooses to do, whereas loan modification is generally something a borrower needs to do, often as a last resort.

Here’s a look at the pros and cons of each option.

Benefits of Loan Modification

While a loan modification is rarely a borrower’s first choice, it comes with some advantages. Here are a few to consider.

•   Avoid default and foreclosure. Getting a loan modification can help you avoid defaulting on your mortgage and potentially losing your home as a result of missing mortgage payments.

•   Change the loan’s terms. It may be possible to increase the length of your loan, which would lower your monthly payment. Or, if the original interest rate was variable, you might be able to switch to a fixed rate, which could result in savings over the life of the loan.

•   Avoid closing costs. Unlike a loan refinance, a loan modification allows you to keep the same loan. This helps you avoid having to pay closing costs (or other fees) that come with getting a new loan.

Drawbacks of Loan Modification

Since loan modification is generally an effort to prevent foreclosure on the borrower’s home, there are some drawbacks to be aware of.

•   It could have a negative effect on your credit. A loan modification on a credit report is typically a negative entry and could lower your credit score. However, having a foreclosure — or even missed payments — can be more detrimental to a person’s overall creditworthiness.

•   Tapping home equity for cash is not an option. Unlike refinancing, a loan modification cannot be used to tap home equity for an extra lump sum of cash (called a cash-out refi). If your monthly payments are lower after modification, though, you may have more funds to pay other expenses each month.

•   There is a hardship requirement. It’s typically necessary to prove financial hardship to qualify for loan modification. Lenders may want to see that your extenuating financial circumstances are involuntary and that you’ve made an effort to address them, or have a plan to do so, before considering loan modification.

Recommended: Guide to Mortgage Relief Programs

Benefits of Refinancing a Loan

For borrowers with a strong financial foundation, refinancing a mortgage or other type of loan comes with a number of benefits. Here are some to consider.

•   You may be able to get a lower interest rate. If your credit and income are strong, you may be able to qualify for an interest rate that is lower than your current loan, which could mean a savings over the life of the loan.

•   You may be able to shorten or extend the term of the loan. A shorter loan term can mean higher monthly payments but is likely to result in an overall savings. A longer loan term generally means lower monthly payments, but may increase your costs.

•   You may be able to pull cash out of your home. If you opt for a cash-out refinance, you can turn some of your equity in your home into cash that you can use however you want. With this type of refinance, the new loan is for a greater amount than what is owed, the old loan is paid off, and the excess cash can be used for things like home renovations or credit card consolidation.

Drawbacks of Refinancing a Loan

Refinancing a loan also comes with some disadvantages. Here are some to keep in mind.

•   You’ll need strong credit and income. Lenders who offer refinancing typically want to see that you are in a solid financial position before they issue you a new loan. If your situation has improved since you originally financed, you could qualify for better rates and terms.

•   Closing costs can be steep. When refinancing a mortgage, you typically need to pay closing costs. Before choosing a mortgage refi, you’ll want to look closely at any closing costs a lender charges, and whether those costs are paid in cash or rolled into the new mortgage loan. Consider how quickly you’ll be able to recoup those costs to determine if the refinance is worth it.

•   You could set yourself back on loan payoff. When you refinance a loan, you can choose a new loan term. If you’re already five years into a 30-year mortgage and you refinance for a new 30-year loan, for example, you’ll be in debt five years longer than you originally planned. And if you don’t get a lower interest rate, extending your term can increase your costs.

Is It Better to Refinance or Get a Loan Modification?

Whether a refinance or loan modification is better depends on your situation. If you have solid credit and are current on your loan payments, you’ll likely want to choose refinancing over loan modification. To qualify for a refinance, you’ll need to have a loan in good standing and prove that you make enough money to absorb the new payments.

If you’re behind on your loan payments and trying to avoid negative consequences (like loan default or foreclosure on your home), your best option is likely going to be loan modification. Provided the lender is willing, you may be able to change the rate or terms of your loan to make repayment more manageable. This may be more agreeable to a lender than having to take expensive legal action against you.

Recommended: Debt Consolidation Calculator

Alternatives to Refinancing and Loan Modification

If you’re having trouble making your mortgage payments or just looking for a way to save money on a debt, here are some other options to consider besides refinancing and loan modification.

Mortgage Forbearance

For borrowers facing short-term financial challenges, a mortgage forbearance may be an option to consider.

Lenders may grant a term of forbearance — typically three to six months, with the possibility of extending the term — during which the borrower doesn’t make loan payments or makes reduced payments. During that time, the lender also agrees not to pursue foreclosure.

As with a loan modification, proof of hardship is typically required. A lender’s definition of hardship may include divorce, job loss, natural disasters, costs associated with medical emergencies, and more.

During a period of forbearance, interest will continue to accrue, and the borrower will still be responsible for expenses such as homeowners insurance and property taxes.

At the end of the forbearance period, the borrower may have to repay any missed payments in addition to accrued interest. Some lenders may work with the borrower to set up a repayment plan rather than requiring one lump repayment.

Mortgage Recasting

With a mortgage recast, you make a lump sum payment toward the principal balance of the loan. The lender will then recast, or re-amortize, your remaining loan repayment schedule. Since the principal amount is smaller after the lump-sum payment is made, each monthly payment for the remaining life of the loan will be smaller, even though your interest rate and term remain the same.

Making Extra Principal Payments

With any type of loan, you may be able to lower your borrowing costs by occasionally (or regularly) making extra payments towards principal. This can help you pay back what you borrowed ahead of schedule and reduce your costs.

Before you prepay any type of loan, however, you’ll want to make sure the lender does not charge a prepayment penalty, since that might wipe out any savings. You’ll also want to make sure that the lender applies any extra payments you make directly towards principal (and not towards future monthly payments).

The Takeaway

If you’re interested in getting a lower interest rate, lowering your monthly debt payment, or cashing out some equity, refinancing likely makes more sense than a loan modification. If, however, you’re dealing with financial challenges and at risk of home foreclosure, you may want to look into a loan modification, which could be easier to qualify for than loan refinancing. When debt grows, you might also look into debt consolidation loans.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

What are the disadvantages of loan modification?

A loan modification typically comes with a hardship requirement. A lender may ask to see proof that your financial circumstances are involuntary and that you’ve made an effort to address them before considering loan modification. A loan modification can also have a negative effect on your credit.

A loan modification can also have a temporary negative effect on your credit.

What is loan refinancing?

Loan refinancing replaces an existing loan with a new one, which pays off the old one. Then, going forward, the borrower makes payments on the new loan with its new interest rate and terms. This can help a borrower snag a lower interest rate, lower monthly payments, or shorten the loan repayment period.

Photo credit: iStock/AlexSecret

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SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

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