How Does Refinancing Can Affect Your Credit Score?

Typically, your credit health will not be strongly affected by refinancing, but the answer isn’t always black and white. Whether you’re still considering your options or already made your choice, we’ve outlined what you need to know about refinancing below.

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.

 

What Is Refinancing?

 

Since refinancing is essentially replacing an existing debt obligation with another debt obligation under different terms, it’s not a decision to take lightly. Refinancing is defined by taking on a new loan to pay off the balance of your existing loan balance. How you approach a refinancing decision depends on whether it’s for a home, car, student loan, or personal loan.

 

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:

How Refinancing Can Lower Your Credit Score

 

Refinancing can lower your credit score in a couple different ways:

Credit check: When you apply to refinance a loan, lenders will check your credit score and credit history. This is what's known as a hard inquiry on your credit report—and it can temporarily cause your credit score to drop slightly. However, the money you save through refinancing, especially on a mortgage, usually outweighs the negative effects of a small credit score dip. And as you pay off your new loan over time, your credit scores will likely improve as the result of strong payment history.

Applying for different loans over a period of several months, on the other hand, could have a lasting negative effect on your credit score.

Multiple loan applications: To find the best loan terms when refinancing, you'll probably apply to several different lenders to see which one gives you the lowest interest rate. To keep all of these hard inquiries from hurting your credit score, make sure to submit all your loan applications within a short period.

Closing an account: The loan you are refinancing will be closed, which can also lower your credit score because you are closing a long-standing credit account. However, some credit scoring models will take into account your payment history on the closed loan. As long as the closed account was closed in good standing, this lessens the hit to your credit score. In addition, as you pay down the new loan, your credit score should improve again. Most credit scoring models treat loan inquiries between a 14-day to 45-day period as one inquiry, minimizing the hit to your credit score.

1) Having a Solid Credit Score

 

You won’t be in a strong position to negotiate to refinance 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 20 percent equity in a property when refinancing a home.

 

How Does Refinancing Hurt Your Credit?

 

As a reminder, the main loan-related factors that affect credit scores are credit inquiries and changes to loan balances and terms. Refinancing might seem like a good option, but exactly how does refinancing hurt your credit? In short, refinancing may temporarily lower your credit score.

 

Credit Inquiries

 

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. 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.

 

Keep in mind that credit inquiries made during a 14–45 day the 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 of the impact of a hard inquiry on your credit decreases over time anyway.

 

Changes to Loan Balances and Terms

 

Lenders may report it as the same loan with changes or as an entirely new loan with a new open date. 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.

 

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. If your loan from refinancing is reported as a new loan, your credit score could be more prominently affected.

 

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.

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