Before you make any big financial decision, it’s crucial to learn how it may affect your credit score.
If you’re looking to refinance, it’s natural to wonder if it might hurt your credit.
Your credit score might drop slightly initially after refinancing, but only for a brief period of time. But your credit score may likely rebound–and even improve–If you make your new loan payments on time.
We’ve outlined what you need to know about refinancing, whether you’ve already made your choice or are still considering your options.
Does Refinancing Hurt Your Credit?
While refinancing could initially cause a slight decrease in your credit score, it shouldn’t have a long-lasting impact. However, it also depends on your current credit health.
What Is Refinancing?
Refinancing is when you take on a new loan to pay off the balance of your existing loan. You’re essentially replacing an existing debt obligation with a new debt obligation that’s under different terms.
Your approach depends on whether you’re refinancing a home, car, student loan, or personal loan. It’s not a decision to take lightly.
Does Refinancing Hurt Your Credit? 3 Factors to Consider
If you’re worried about how refinancing will affect your credit health, remember that there are multiple factors that play into whether or not it hurts your credit score, but the top three factors are:
1) Having a Solid Credit Score
You won’t be in a strong position to negotiate refinancing terms without decent credit.
2) Earning Sufficient Income
If you can’t prove that you can keep up with loan payments after refinancing, it won’t be possible.
3) Proving Sufficient Equity
You’ll also need to provide assurance that the payments will still be made if your income can’t cover the cost. It’s recommended that you should have at least a 20 percent equity in a property when refinancing a home.
How Does Refinancing Hurt Your Credit?
Refinancing might seem like a good option, but exactly how does refinancing hurt your credit? In short, refinancing may temporarily lower your credit score. As a reminder, the main loan-related factors that affect credit scores are credit inquiries and changes to loan balances and terms.
Whenever you refinance, lenders run a hard credit inquiry to verify your credit score. Hard credit inquiries typically lower your credit scores by a few points. Try to avoid incurring several new inquiries by using smart rate shopping tactics. It also helps to get all your applications in during a 14–45 day window.
Keep in mind that credit inquiries made during a 14–45 day period could count as one inquiry when your scores are calculated, depending on the type of loan and its scoring model. Regardless, your credit won’t be permanently damaged because the impact of a hard inquiry on your credit decreases over time anyway.
Changes to Loan Balances and Terms
How much your credit score is impacted by changes to loan balances and terms depends on whether your refinanced loan is reported to the credit bureaus. Lenders may report it as the same loan with changes or as an entirely new loan with a new open date.
If your loan from refinancing is reported as a new loan, your credit score could be more prominently affected. This is because a new or recent open date usually means that it is a new credit obligation, therefore influencing the score more than if the terms of the existing loan are simply changed.
How Do Common Types of Refinancing Affect Your Credit?
Refinancing could help you pay off your loans quicker, which could actually improve your credit. However, there are multiple factors to keep in mind when refinancing different types of loans.
Refinancing a Mortgage
Refinancing a mortgage has the biggest potential impact on your credit health, and it can definitely affect your FICO score. How can you prevent refinancing from hurting your credit too much? Try concentrating your credit inquiries when you shop mortgage rates to a 14–45 day window — this will help prevent multiple hard inquiries. Also, you can work with your lenders to avoid having them all run your credit, which could risk lowering your credit score.
If you’re unsure about when to refinance your mortgage, do your research to capitalize on the best timing. For example, refinancing your mortgage while rates are low could be a viable option for you — but it depends on your situation. Keep in mind that losing your record of paying an old mortgage on time could be harmful to your credit score. A cash-out refinance could be detrimental, too.
Refinancing an Auto Loan
With auto loan refinancing, you’re taking out a second loan to pay off your existing car debt. In some cases, refinancing a car loan could be a wise move that could reduce your interest rate or monthly payments. For example, if you’re dealing with an upside-down auto loan, you might consider refinancing.
Would you prefer a longer or shorter loan term? A longer loan term would mean lower monthly payments, but it’ll also take you longer to pay off and you could spend far more money on interest. And remember that your car will constantly be depreciating in value.
If you plan on selling your vehicle within 5 years, a long-term loan might not be a good option for you.
Refinancing Student Loans
When it comes to student loan refinancing, a lower interest rate could lead to major savings. Refinancing your student loans can be rewarding and can save you money in the long-term.
You can usually refinance both your federal and private student loans. However, be aware that refinancing a federal loan with a private loan will have an impact on the repayment options available to you.
Federal loans offer significantly better repayment options than private loans, so keep that in mind before making your decision.
|If the cost of borrowing is low, securing a lower interest rate is possible||Credit scores can drop due to credit checks from lenders|
|If your credit score greatly improved, you can refinance to get a better rate||Credit history can be negatively affected by closing a previous loan to refinance|
|Refinancing a loan can help you lower expenses in both the short term and long term||Refinancing can involve fees, so be sure to do a cost-benefit analysis|
How to Prevent Refinancing from Hurting Your Credit
If you plan ahead, you can make efforts to limit how much refinancing negatively impacts your credit and overall financial health.
Before you begin the refinancing process, see if there’s anything you can do to boost your credit score so you can secure a better rate. Perhaps you can pay off one of your smaller loans or credit card debt.
Try to prepare by reading your credit reports closely, and make sure there are no errors that could keep your credit application from being approved at the best possible rate. Stay one step ahead of any errors, so you still have time to dispute them.
If refinancing makes sense for your situation, you shouldn’t be concerned about it hurting your credit. Refinancing is very common and, most of the time, it’s relatively easy for your credit score to bounce back.
As long as you’re prioritizing your overall financial health through smart decision-making and budgeting, refinancing shouldn’t adversely hurt your credit in the long run.
How to Figure Out If Refinancing Has Hurt Your Credit
Before you file an application for a refinancing loan, check your credit score so you know where it stands before lenders make hard inquiries into your credit.
How do you check your credit score? You have two options.
- You can get your credit score from one of the three major credit bureaus–you’re entitled to one free credit check per year, for each of the three bureaus.
- You can check your credit score for free with the Mint app, which is the easiest method. Mint will also update your credit score every month, so it’s useful for ongoing credit monitoring.
After you’ve been qualified by a lender, check your credit score again. It’s possible that your credit score may have dropped by 5 or 10 points. That’s common when you’re applying for a new loan, and it’s not something you should be too worried about.
Your credit score should bounce back within a few months if you’re making your loan payments on time.
If your credit score dropped by more than 10 or 20 points, then it could signal a bigger credit problem or an error in the refinancing process.
What To Do If You Notice Refinancing Has Affected Your Credit?
If you notice that your refinancing loan causes alarming changes when you check your credit score, be sure to reach out to your creditor or consider filing a dispute.
One of the most common errors is that multiple hard inquiries were not counted as a single inquiry. As mentioned earlier, you’re typically given a 14- to 45-day window when you’re applying for a refinancing loan. During that window, all credit inquiries that your lenders make will be counted as single inquiry.
A single inquiry shouldn’t hurt your credit score by much.
However, multiple inquiries may have a bigger impact on your credit score. Check your records and make sure that you applied for every loan within a short period of time. Reach out to your creditor and verify they’ve only counted a single credit inquiry when determining your credit score.
You can file a dispute with the credit bureaus if you feel like they made a mistake when reporting your credit. Ask your lender which bureau they received your credit report from, and file a dispute with that credit bureau.
You may have to file a dispute with multiple credit bureaus if your lenders receive their credit reports from different providers.
Pros and Cons of Refinancing Your Loan
There are benefits and drawbacks to refinancing a loan. Let’s cover the benefits first:
Pros of Loan Refinancing:
- Saving Money: You could save money on interest payments if your new loan has better interest rates than your previous loan.
- Improving Your Credit: If refinancing puts you in a better financial situation, then you’ll have an easier time paying down your debt, which may lead to your credit score improving.
- Getting a Better Term: On a tight budget? You can ease your financial burden by refinancing with a longer term. A longer term will reduce your monthly payments and can make it easier for you to pay your bills.
Cons of Loan Refinancing:
- May Temporarily Hurt Your Credit: Your credit score may take a slight dip due to lenders making credit inquiries and because you’ll have one of your credit accounts closed. But remember that the impact is often very brief and temporary.
- Might Not Save You Money: Refinancing a loan won’t always save you money. Make sure that you’re able to secure rates that are at least 1-2% better than your current loan. Otherwise, refinancing might not be worth the time and trouble.
When Is Refinancing Worth the Risk?
As we’ve mentioned, refinancing will most likely cause your credit score to fall by 5 or 10 points. How do you know whether it’s worth the risk?
Here are a few situations in which it might be ideal to refinance:
- You Pay High Interest: If you’re paying high rates on your loan, refinancing could benefit you if you’re able to secure a lower interest rate.
- You Need a Different Term: Perhaps you have a short-term loan, and are struggling with high monthly payments. Or maybe you have a long-term loan, but you’re capable of making higher monthly payments so you can pay it off faster and save money on interest. Refinancing can help you restructure your loan terms in ways that are more beneficial for you.
- Your Car is Holding Value: Thinking about refinancing a car loan? It might be worth considering if your vehicle is not depreciating too quickly and you don’t plan on selling it within a few years.
- Avoiding a Balloon Payment: Refinancing can help you avoid an upcoming balloon payment.
When Is Refinancing Not Worth the Credit Hit?
When is it not worth it to refinance? Here are a few situations in which you might want to avoid refinancing.
- You’re About to Take Out a Bigger Loan: Hard inquiries will likely impact your credit score, so you might hold off on refinancing—or even filing an application for refinancing—if you plan on taking out a second loan. For example, if you’re about to apply for a mortgage, you may not want to refinance your auto loan. The drop in credit could affect the rates you’re offered on the mortgage.
- You Have Federal Student Loans: When you refinance federal student loans, you’ll lose federal loan benefits like lower rates or income-based payment plans.
- You’re Satisfied with Your Loan Term: If you’re happy with your loan term, then you might not want to refinance if it’s going to change the repayment schedule.
- Can’t Handle the Fees: Just like with a standard loan, you’ll have to pay origination fees, application fees, and other costs when you refinance. You might want to hold off on refinancing if you’re not prepared to cover these costs.
Before you refinance, think carefully about why you’re refinancing and how it will benefit you. Refinancing is a common practice, but you don’t have to do it just because so many other people are doing it. It’s not a financial rite of passage.
Use Mint to Help You Stay Organized While Paying Off Loans
Want to stay on top of your debt? Use the Mint app to keep yourself organized. Mint can help you keep track of your monthly payments, monitor your credit score, and stick to your budget. It’s an excellent tool for anyone trying to improve their financial health.