Refinancing any outstanding loans into a new one with a lower interest rate is key to carrying out effective personal financial planning but can it impact your credit score?
What is refinancing?
Refinancing is the process of taking out a new loan to pay off the debt of an existing loan, thereby changing the terms of the loan agreement.
By refinancing a loan and extending the loan term, qualified borrowers may be able to obtain lower interest rates and lower monthly payments.
Consumers can also benefit from refinancing by consolidating multiple loans into a single, more manageable payment.
As a result, if your credit score has improved since you applied for the original loan, or if your financial plans would benefit from consolidation, refinancing may be a good option.
It can even be a good strategy if you’re having trouble making higher monthly payments—though you’ll almost certainly end up paying more in interest over the life of the loan.
Refinancing a home
To refinance a home means that you replace your existing mortgage with a new mortgage with better terms. Whether or not you should refinance is determined by whether or not you will save enough money. Interest rates, closing costs, and the number of years you plan to stay in your home will all help you determine your potential savings.
A lender will review your finances, just as they did when you first applied for your mortgage, to assess your level of risk and determine your eligibility for the best interest rate. It’s a completely new loan, and it could be with a different lender than the one you used to purchase your home.
The repayment clock on your new loan may also be reset. Assume you’ve been paying on your current 30-year mortgage for five years. That means you have 25 years remaining on your loan. If you refinance a new 30-year loan, you will begin again and have 30 years to repay it. If you refinance to a new 20-year loan, you will pay off your loan five years sooner.
Refinancing a car
A loan refinance car is when you replace your current auto loan with a new one. Your original loan is paid off, and you begin making monthly payments on the new loan. The refinancing application process is quick, and many lenders can/may make decisions quickly.
What credit card refinancing is
Credit card refinancing is the process of consolidating multiple high-interest credit card payments into a single, lower-interest payment. A credit card refinancing loan or a balance transfer credit card are the two most common ways to refinance your credit card.
What refinancing student loans means
Student loan refinancing enables you to consolidate all or some of your loans into a single new loan, often at a lower interest rate, which may help you pay less over time or provide you with a longer repayment term, which will lower your monthly payment.
See our article on how How Loan refinancing Works
Will Credit Card Refinancing Hurt Your Credit Score?
Credit card refinancing or debt consolidation can lower your credit score temporarily but improve it in the long run if you make on-time payments.
Applying for another credit card usually results in a few points being deducted from your credit score. The average age of your credit cards is also a consideration. The higher your score, the higher the average; therefore, adding a new one lowers the average.
When you consolidate your debts with a loan, lenders conduct a “hard inquiry,” which lowers your credit score by a few points. If you’re shopping around and make several inquiries in a short period of time, typically 14-45 days, the credit bureaus treat it as one inquiry. Inquiries spread out over a longer period of time will have a greater impact.
Your credit score will begin to improve once you transfer the balance or pay it off with a loan. More available credit vs. credit used (also known as credit utilization) adds points with a balance transfer. Late payments and adding to your debt will harm your credit score regardless of which option you choose.
Does Refinancing Hurt Your Credit?
The answer to the question above can be expressed in the following ways.
- Credit check
- Multiple loan applications
- Hard Inquiries
- New Credit
- Old loan
- New loan
a. Credit check
When you shop for the best refinancing terms, lenders typically run a credit check to determine your creditworthiness. If you rely solely on the prequalification process, you may only be subjected to soft credit checks that will not harm your credit score.
However, some lenders subject applicants to hard credit inquiries, which remain on credit reports for two years and can result in a five-point drop in score.
b. Multiple loan applications
Each time you apply for refinancing with a different lender, the hard credit inquiry will appear on your credit report, potentially lowering your score. Fortunately, you can keep this to a minimum by applying to all lenders within a short period—ideally, within a 14- to 45-day window, depending on the scoring model.
c. Hard Inquiries
A hard inquiry, also known as a hard pull, is a common tool used by lenders and creditors to assess the creditworthiness of a potential borrower. After a potential borrower submits a loan or credit application, the lender conducts a hard inquiry to check the borrower’s credit.
Borrowers must authorize hard credit checks, though many are unaware of this requirement. Credit check authorization is typically required by lenders as a “must do” if the credit application is to be accepted.
Typically, a single hard credit pull will not have a significant impact on a borrower’s credit report. In most cases, the borrower’s credit score is reduced by no more than five points.
d. New Credit
According to most credit scoring formulas, the amount of new credit you’ve taken out may account for 10% of your credit score. Lenders are wary of prospective borrowers who have a recent history of aggressively taking on new debt.
This is important for a refi because simply put, older loans are better than new loans. This is another reason why refinancing may result in a credit score drop. Let’s take a closer look at the reasoning.
e. Old Loan
According to most credit scoring formulas, the amount of new credit you’ve taken out may account for 10% of your credit score. Lenders are wary of prospective borrowers who have a recent history of aggressively taking on new debt.
This is important for a refi because simply put, older loans are better than new loans. This is another reason why refinancing may result in a credit score drop. Let’s take a closer look at the reasoning.
f. New Loan
When you refinance, your new loan of $150,000 includes only the $150,000 you haven’t paid off. Sure, the goal is to pay off the entire loan, but in the eyes of credit scoring companies, you’ve exchanged a 50%-paid-off loan for a 0%-paid-off loan.
That’s why, even though your new loan has the same “amount due,” the trade-off may set off some credit formula alarms and result in an immediate drop in your credit score.
How to protect your credit when refinancing Your Credit
Although the effect of refinancing on your credit score is usually temporary, there are steps you can take to mitigate the damage:
- Give yourself 45 days
- Do a “soft” inquiry
- Get an initial quote from lenders
- Leave your credit alone
#1. Give yourself 45 days
Any hard credit inquiries made within 45 days are bundled and scored as a single inquiry under the new FICO credit model. So, even if you get quotes from several lenders, limiting your comparison shopping to 45 days will only result in one hit to your credit.
#2. Do a “soft” inquiry
Instead of having a lender run a hard inquiry, check your credit score yourself well in advance of refinancing. You can work to improve your score once you know what it is.
#3. Get an initial quote from lenders
Request that lenders provide you with a preliminary quote based on your credit score without pulling your credit. Once you’ve shortened the field, let the final few lenders run a full credit check and formally offer you a new loan.
#4. Leave your credit alone
Aside from paying off any outstanding balances, avoid making any significant changes to your credit during the refinancing process. “Don’t buy a new car, get a new credit card, or do anything that could impact your credit score while working toward your new credit.
Conclusion
You are more likely to get a lower interest rate if you refinance. As a result, monthly mortgage payments would be reduced. You have the option of switching from a longer-term loan to a shorter-term loan. You can reduce your interest payments if interest rates are low.
You can also pay off your loan faster and be debt-free sooner. You accumulate equity by making monthly loan payments over time and improving your credit score.
Does Refinancing Hurt Your Credit- FAQs
Is refinancing worth it?
Refinancing is usually worthwhile if you can reduce your interest rate enough to save money both month to month and over time. Depending on your current loan, lowering your rate by 1%, 0.5%, or even 0.25% may be enough to justify refinancing.
This means that, even in a rising-rate environment, some homeowners may benefit from a refinance.
How does refinancing affect your credit?
Here are ways that refinancing affects your credit:
- Credit check
- Multiple loan applications
- Hard Inquiries
- New Credit
How much does refinancing hurt your credit?
5 points. As long as you do it correctly, refinancing should only have a minor impact on your credit score.
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