Refinancing a loan can affect your credit, but the impact should be minor and it should pass quickly. You can minimize that impact by understanding the refinancing process and planning your refinancing carefully.
What Is Refinancing?
Refinancing replaces one or more loans with another loan. You borrow money and use it to pay off your old loan.
If interest rates have gone down or your credit has improved since you got your loan, you may be able to refinance at a lower rate. That lets you replace an expensive loan with a cheaper one. Refinancing is most useful with large long-term loans.
Don’t rush into refinancing. Be sure that your gains from a better rate are greater than the costs of closing the new loan. While a refinance might look good on paper due to a lower interest rate, if it takes longer to pay or has higher fees associated with it, your new loan may end up costing you more than the old one. Review the numbers carefully and be sure refinancing will help you.
How Refinancing Can Affect Your Credit Score
Refinancing can affect your credit in several ways.
- Your new lender will do a credit check, which places a hard inquiry on your credit report. That can affect your credit, but the impact of one hard inquiry is usually minor and does not last long.
- If you’re looking for the best rate on a refinancing loan, you’re likely to apply to more than one lender. That could mean a series of hard inquiries, which can have a bigger impact on your credit. Credit reporting companies treat multiple inquiries for the same type of loan as a single inquiry if they are made within a limited time. Try to do all your loan shopping in a 2-week period.
- When you refinance your loan, the old loan will be closed. A long term loan with a history of reliable payment is an asset to your credit, and closing it could have an impact. Your new loan will be a new obligation with no payment history.
- If you have a short credit history and a small number of accounts your refinancing will have a greater impact on your credit. The fewer items there are on your record, the greater the impact of each item.
- Repeated refinancing may have a greater impact on your credit. Multiple refinancings will generate more hard inquiries and may suggest that it’s hard for you to maintain the terms of a loan contract.
- If you take a cash-out refinance, you will have a higher balance than before. Cash-out refinancing creates a new mortgage that is larger than the balance due on the old one, and the homeowner receives the difference in cash. This increases your total debt and could leave you with a larger monthly payment, both of which may affect your credit.
In most cases the impact of these changes is small. Your credit should recover quickly as long as you make the payments for your new loan on time.
Refinancing Specific Types of Loans
Refinancing Your Mortgage
Mortgages usually involve relatively large sums and extended payment periods, so even a small improvement in your interest rate can generate significant savings. You’ll still need to learn about mortgage refinancing and study the figures carefully to make sure you’ll come out ahead.
Pay particular attention to the final payments on your old loan. Be sure that every payment is made on time. A late payment can hurt your credit even if you pay off the entire loan soon after.
Refinancing Your Car Loan
If interest rates have dropped or your credit has changed since you got your car loan, you may want to consider refinancing. Some car owners also refinance with a longer-term loan to lower their monthly payment. Remember that a longer loan term can raise the total cost of the car even with a lower interest rate.
You may not be able to refinance if the market value of your car is lower than the balance remaining on your loan. If there is a prepayment penalty on your original loan it may negate the savings from refinancing.
As with mortgage refinancing, be sure that all payments on the old loan are completed on time and the old loan is properly retired.
Refinancing to reduce your monthly payment could help your credit if your current payments are high and you’re having trouble making them. Missing a payment could hurt your credit more than refinancing would.
Refinancing a Personal Loan
Refinancing a personal loan makes sense if you can get substantially better rates on a new loan. You might also consider refinancing if you have several personal loans outstanding and you can take a single new loan to pay them off. Having fewer open accounts with unpaid balances could help your credit.
As always, be sure that all payments on the accounts you’re closing are made on time.
Should I Refinance or Not?
Refinancing can affect your credit but the impact is usually minor. Be sure to review your credit reports after your refinancing is complete. Make sure the old accounts are properly closed and all payments are reflected in your report.
Timing is important. If you expect to be negotiating a significant loan soon, put off refinancing (or anything else that could be a short-term drag on your credit) until you’ve closed the deal. If you’re about to shop for a new house, don’t refinance your car loan until after you’ve settled your new mortgage. Refinancing won’t have a major impact on your credit, but even a few points can make a difference.
If your credit has improved significantly since you took out a loan, there’s a good chance that refinancing could get you a better deal. If you aren’t sure about your credit score, check your score and find out. You’ll have to review the costs and benefits carefully, but if the numbers favor a refinance, don’t let credit concerns hold you back.