Is Refinancing Bad for Your Credit Score ? Here’s What to Expect
The Federal Reserve recently announced it will begin cutting interest rates this fall. The United States is at at the highest interest rate in over 20 years, meaning it is more expensive to borrow. This upcoming rate cut is a unique opportunity to refinance and save money. But, before making any significant financial decision, it's essential to understand how it may affect your credit score. Refinancing, while potentially beneficial, often raises the question: Will this hurt my credit?
The short answer is that refinancing might cause a temporary dip in your credit score, but this effect is usually short-lived. With timely payments on your new loan, your credit score can rebound and potentially improve over time. Here’s a comprehensive look at what refinancing entails and how it may impact your credit.
What Is Refinancing?
Refinancing involves replacing an existing loan with a new one under different terms. This process can apply to various types of loans, including mortgages, auto loans, student loans, and personal loans. The main goal of refinancing is usually to secure better terms such as a lower interest rate, a different repayment schedule, or reduced monthly payments. However, because refinancing essentially means taking on new debt, it’s not a decision to take lightly.
Does Refinancing Hurt Your Credit? Key Factors to Consider
When evaluating how refinancing might affect your credit score, it’s crucial to consider several factors:
- Your Current Credit Health: The stronger your credit score before refinancing, the better terms you can negotiate. Lenders assess your creditworthiness to determine the interest rates and terms they can offer.
- Proof of Sufficient Income: Lenders want assurance that you can keep up with loan payments after refinancing. Demonstrating a stable and sufficient income is critical to securing favorable refinancing terms.
- Equity in Your Property: If you’re refinancing a mortgage, having at least 20% equity in your home can significantly improve your chances of approval and help you secure better loan terms.
How Does Refinancing Impact Your Credit?
Refinancing can have both immediate and short-term effects on your credit score. Here's how it works:
- Credit Inquiries: When you apply for refinancing, lenders perform a hard credit inquiry to assess your credit score. This inquiry can lower your score by a few points, but this impact diminishes over time. To minimize the effect, try to limit your applications to a 14-45 day window. During this period, multiple inquiries may be treated as a single inquiry by credit scoring models.
- Changes to Loan Balances and Terms: Depending on how the refinanced loan is reported to credit bureaus, it could be seen as a new loan, which might have a more pronounced impact on your credit score. However, this impact is typically temporary, especially if you continue to make timely payments.
Got debt? Download our free e-book to help you crush your debt and take control of your financial future here.
How to Prevent Refinancing from Negatively Impacting Your Credit
- Boost Your Credit Score Before Refinancing: If possible, take steps to improve your credit score before you apply. Paying off small debts or correcting errors on your credit report can make a significant difference.
- Limit Credit Inquiries: To avoid multiple hits to your credit score, try to complete your refinancing applications within a 14-45 day window. This can help ensure that all inquiries are treated as a single one.
- Check for Errors: Before refinancing, review your credit reports for any errors that could hurt your score. Dispute any inaccuracies with the credit bureaus to ensure your report reflects your true credit health.
What to Do If Refinancing Affects Your Credit
If you notice a significant drop in your credit score after refinancing, don’t panic. First, check to see if the decline is due to multiple hard inquiries being counted separately. If this is the case, reach out to the credit bureaus to correct the error. If the drop in your score is more substantial, it may indicate a larger issue, such as incorrect reporting by your lender. In such cases, contacting your lender and disputing any errors is essential to protect your credit.
The Pros and Cons of Refinancing
Pros of Refinancing:
- Potential Savings: Refinancing can reduce your interest payments, saving you money in both the short and long term.
- Improved Loan Terms: Refinancing can offer more favorable terms, such as lower monthly payments or a shorter loan term.
- Credit Improvement: Successfully managing a refinanced loan can lead to an improved credit score over time.
Cons of Refinancing:
- Temporary Credit Impact: Your credit score may take a slight dip due to the hard inquiries and changes in your credit report.
- Costs and Fees: Refinancing often involves fees, such as application and origination fees, which should be factored into your decision.
- Potential for Little Savings: If the new interest rate isn’t significantly lower than your current rate, refinancing might not provide the financial benefits you’re seeking.
When Is Refinancing Worth the Risk?
Refinancing can be a smart financial move under the right circumstances:
- High Interest Rates: If your current loan carries high interest rates, refinancing could help you secure a lower rate, saving you money over time.
- Need for Different Loan Terms: If you’re struggling with your current loan terms, refinancing can offer relief by extending or shortening the loan term to better suit your financial situation.
When Should You Avoid Refinancing?
There are times when refinancing might not be the best choice:
- Upcoming Major Loan Applications: If you’re planning to apply for a significant loan, such as a mortgage, it might be best to avoid refinancing until after the new loan is secured.
- Federal Student Loans: Refinancing federal student loans can lead to the loss of valuable repayment options and protections, making it a less attractive option for some borrowers.
- Unfavorable Fees: If the costs associated with refinancing outweigh the benefits, it may not be worth pursuing.
About Us:
Investrio is an all-in-one personal finance platform that helps you reduce your debt and move forward, financially. We're here to support you with our platform and financial coaches. Ready to crush debt? Join our waitlist here.
