Refinancing an outstanding loan can be a prudent way to reduce your outgoings, with the goal being to secure a lower interest rate and therefore lower monthly repayments. But whether you’re refinancing a mortgage, a personal loan or an auto loan, you’ll likely find that your credit rating will be impacted, at least temporarily. So why does refinance hurt your credit, and is there anything you can do to negate the effects?
Why does refinance hurt your credit?
The main reason that refinancing can affect your credit score is that the lender will run a credit check when processing your application (what’s known as a hard inquiry) which will always result in a temporary dip to your score. These inquiries can stay on your report for around two years, though their impact on your score will begin to lessen after the first six months.
Then there’s the fact that you’ll be closing an old credit account and replacing it with a new one, which will reduce the overall age of your accounts and therefore lower your score. However, some credit bureaus will take your payment history into consideration before determining the impact on your rating, and if you were up to date on your old loan, any dip should be lessened. Just bear in mind that new accounts will always be viewed less favorably, as you haven’t been able to build up a payment history yet.
There may be additional aspects to consider as well, depending on the kind of loan you’re looking to refinance.
Refinancing your mortgage
With low interest rates recently offering the chance to save big on mortgage payments, it’s little wonder that so many are seeking the best refinance mortgage companies. However, it’s important to be on the ball when syncing up your payment schedules to prevent your score being downgraded further than you anticipated.
You’ll need to continue making repayments to your old loan whilst your new one is being approved, and make sure you don’t miss that final repayment. Even if the new loan is designed to cover it, there’s the chance that it could arrive after the payment becomes due, which could result in a greater hit to your credit score. It’s your responsibility to make sure that all payments are made on time, so don’t fall at the final hurdle.
A refinanced mortgage could lower your score in another way, too, because the new balance will be 100% of the origination amount. Any information about how much of the loan you previously paid off won’t carry over, so that uplift to your score will be lost. That said, it could still pay to refinance your mortgage, simply for the potential to substantially lower your repayments.
Refinancing a personal loan
Personal loans can impact your credit score in a number of ways, and refinancing such a loan is no exception. However, as with other forms of refinancing, the dip will primarily be driven by hard inquiries on your credit report and therefore should be both minimal and temporary. You may even find that refinancing can improve your score over time, provided you manage the new loan appropriately.
This is particularly the case if you’re refinancing for debt consolidation purposes – as well as making your repayments more manageable, consolidating several loans into one will mean you have fewer accounts with outstanding balances, which can have a positive impact on your score. Find out which loans to pay off first if you’re considering going down this route.
Refinancing your auto loan
If it’s a car loan you need to refinance, the same general considerations apply – there’ll be a hard inquiry on your credit report, and you’ll need to make sure that you can keep up with the future repayments to repair your score effectively. Just make sure you’re finding the best auto loan for your needs, which could go a long way to reducing your repayments. Here’s how to find the right auto loan for you.
How to minimise the impact on your credit score
Although the impact of refinancing on your credit score will usually be minimal, there are still things you should bear in mind to ensure it isn’t a bigger hit than you’d like, and to bring it back up to scratch as quickly as possible:
- Compare rates in a short time frame. Lenders know that consumers will want to compare several different refinancing rates before making their decision, which is why they won’t penalise you for making several applications for the same kind of loan in a relatively short time frame. Just keep that time frame to days or weeks, rather than months.
- Stay up-to-date with your repayments. You may be able to speed up the process of raising your score by sticking to the terms of your new loan agreement, which means being absolutely certain that you’ll be able to keep up with your repayments.
- Keep additional credit applications to a minimum. Although applying for a few of the same kinds of loan in a short space of time won’t impact your score too much, applying for several types of finance will. Applying for too much credit is an indication to lenders that you’re struggling financially, so once you’ve secured your refinancing loan, try to refrain from further applications for at least a few months.
- Check your report. Knowing where you stand in terms of your credit score can be one of the best ways of making sure you keep it in check. This is particularly true if there are errors that need to be fixed in order to bring your report back into good standing, and something where the best credit repair services can help.
Is refinancing worth it?
While it’s true that refinancing a loan will result in a temporary dip to your credit score, the real-world impact on your finances is likely to be small. Unless you’ve repeatedly applied to refinance over the years, a few hard inquiries are unlikely to prevent a lender from offering you finance in the future; they’re far more likely to be concerned with your payment history and credit utilization ratio when determining your eligibility for credit.
Indeed, the money you could save by refinancing could easily outweigh the negative impact of a slight credit score blip, and provided you stick to the terms of your new credit agreement, you’ll be able to improve it in no time.