Refinancing debt can be a financially savvy move in a variety of situations. Whether you’re looking for a lower monthly payment or a reduced interest rate, refinancing can provide significant benefits. However, one question often arises: does refinancing hurt your credit score? The good news is that any negative impact on your credit is generally temporary. Let’s take a closer look at what happens to your credit score when you refinance different types of debt.
How Refinancing Can Lower Your Credit Score
Refinancing a loan can potentially harm your credit score in a few ways:
Closing the Old Account
Closing an old account can affect your credit score, as the length of your credit history accounts for 15% of your FICO score. However, closing an old account in good standing can still have a positive impact on your credit score. The history of these accounts can remain on your credit reports for up to 10 years. Additionally, making on-time payments on the new loan will gradually improve your credit score.
Hard Inquiry
When you apply for a new loan, it results in a hard inquiry on your credit reports. This can have a temporary negative impact on your credit score. However, the effects of a hard inquiry typically last only a few months.
Multiple Loan Applications
If you’re searching for the best deal when refinancing, you may apply with multiple lenders. However, this can lead to multiple hard inquiries and loan applications, which may negatively affect your credit score. The good news is that many credit scoring models treat multiple loan applications of the same type as a single inquiry if they occur within a specific time period, typically 14 to 45 days.
Refinancing Different Types of Debt
Each type of refinanced debt comes with its own considerations:
- Auto Loans: Refinancing an auto loan can be beneficial if interest rates have dropped or your credit score has improved. However, extending the repayment term may result in higher total interest costs, even with a lower interest rate.
- Student Loans: Refinancing student loans can be advantageous if you qualify for a lower interest rate. However, refinancing federal student loans with a private lender means giving up federal protections and forgiveness programs. It’s essential to weigh the pros and cons carefully.
- Mortgages: Refinancing a mortgage can be a wise decision if it results in a lower monthly payment or interest rate. However, missing a mortgage payment on your original loan during the refinancing process can significantly damage your credit score.
- Personal Debt: Refinancing personal loans or credit card debt can help consolidate your debts at a lower interest rate. Although refinancing may temporarily lower your credit score due to a hard inquiry, making on-time payments on the new loan will help your score recover.
When Should You Refinance Your Loan?
Refinancing is not always the best option. Consider these factors when deciding whether to refinance:
- Qualifying for a More Affordable Monthly Payment: If refinancing provides a more affordable monthly payment, it may be a good opportunity for you.
- Improved Credit Score: A better credit score can qualify you for a lower interest rate or more favorable terms.
- Removing Someone from the Loan: If you need to remove a borrower from the loan, refinancing may be necessary.
- Higher Interest Rates or Total Loan Costs: If interest rates have increased or the total loan costs are significantly higher, it may be best to stick with your current loan.
What to Do After Refinancing
After refinancing a loan, there are a few steps you can take to protect and improve your credit score:
- Avoid Racking Up Revolving Debt: Keeping credit card debt below 30% of your available credit limits, or even below 10%, can positively impact your credit score.
- Monitor Your Credit Score: Use credit building and monitoring services to keep track of your credit score over time.
- Pay Your Bills Early or On Time: Consistently making early or on-time payments is the most effective way to improve your credit score.
How to Protect Your Credit When Refinancing Your Home
Refinancing a home loan requires careful attention to detail. To protect your credit during the refinancing process, ensure that you:
- Keep Track of Your Old Mortgage: Pay attention to the due date and balance of your old mortgage to avoid accidentally missing a payment.
- Avoid Skipping Mortgage Payments: Skipping a payment on your old mortgage before it’s paid off can have negative consequences if the payoff is delayed.
Time Stamp: Refinancing Can Benefit You, But Run the Numbers First
While refinancing may temporarily impact your credit score, responsible credit management will yield positive results in the long run. It is essential to carefully evaluate the financial benefits of refinancing and consider the potential costs. Use a loan calculator to determine whether refinancing is the right move for you.
Frequently Asked Questions (FAQ)
Does refinancing have any negative effects?
Refinancing a loan may result in a temporary decrease in your credit score due to a hard inquiry. However, if refinancing enables you to save money on interest or achieve a more suitable monthly payment, the benefits often outweigh the potential impact on your credit score.
At what point is it not worth it to refinance?
Refinancing may not be worthwhile if the closing costs or fees eliminate the financial benefits. Additionally, if the new loan will cost you more in the long run, it may be best to stick with your current loan.
How long does a refinance stay on your credit?
A hard inquiry resulting from a refinance can stay on your credit reports for up to two years. However, the new refinance loan will remain on your credit report for as long as it is open. Loans closed in good standing stay on your credit reports for 10 years.
What’s a good credit score to refinance?
The credit score required for a beneficial refinancing opportunity depends on your initial credit score when you obtained the original loan. A good credit score, typically a FICO score of at least 670, will often enable you to secure the best rates and terms when refinancing.
Personal Finances Blog advocates for responsible financial decisions. Refinancing can be a smart move, but it’s crucial to consider your specific circumstances and run the numbers before making a decision. Remember, managing your credit responsibly is key to achieving long-term financial success.