Refinancing can be a smart move financially. It can reduce your monthly payments and potentially save you hundreds or thousands of dollars over the lifetime of your loan.
However, you may be wondering how replacing your current loan with a new one will affect your credit—especially if you’ve done a good job paying all your bills on time, which will have improved your credit score. We’ll take a detailed look into how refinancing affects your credit score and what you should do afterwards.
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How refinancing can hurt your credit
Refinancing may cause a drop in your credit score, albeit a temporary one. Here are the two most common reasons that refinancing can hurt your credit:
1. It will trigger a hard inquiry
When you apply for a new loan to replace your current one, your prospective lender will probably run a credit check on you to determine your creditworthiness. This check will trigger something called a hard inquiry, which will knock a few points off your credit score.
The good news is that although your score will take a dip, it won’t be a serious one. Hard inquiries usually lower your score by no more than 5 points, and credit scores range from 300 (the lowest possible score) to 850 (the highest possible score), so that’s not a significant drop.
Also, even though hard inquiries can stay on your credit report for up to 2 years, their effect on your credit score won’t last that long. Depending on the credit scoring model used, you can expect your score to recover within 6 months (in the case of VantageScore) to one year (FICO). 1 2
2. Taking on a new loan always lowers your credit score
Refinancing a loan usually means closing one credit account (your old loan) and opening a new one. This can affect the following factors involved in the calculation of your credit score:
- Length of your credit history: Your credit age contributes to your credit score—you’ll have a higher score the older your credit accounts are. Although closing your old loan won’t affect the length of your credit history (because closed accounts remain on your credit report), taking on a new loan will still lower the average age of your accounts, hurting your score. 3 4
- Credit balances owed: In addition to looking at the overall amount of debt you have, credit scoring models also consider how much of your loans you’ve paid off compared to the original loan amount. 5 This means that if you paid off a substantial portion of your original loan, you might see your score drop when you replace it with a new, completely unpaid one.
How much does refinancing affect your credit score?
How much refinancing will affect your credit score depends on several factors:
- Whether you take out a new loan
- The average age of your accounts before refinancing
- Whether there are changes in the balance and terms of your new loan compared to your old one
- The number of hard inquiries you trigger
Fortunately, there are things you can do to minimize the impact that refinancing will have on your credit.
How to protect your credit when refinancing
By getting the timing right and avoiding common pitfalls, you can minimize the damage to your credit while ensuring that you get the maximum financial benefit from refinancing.
First we’ll list a few general-purpose tips that apply to all loans. Then we’ll go over a few things to watch out for when you refinance specific types of loans, such as mortgages, auto loans, and student loans.
Tips for protecting your credit when refinancing a loan
- Take note of trends in interest rates: Monitor the average interest rates and forecasts for your loan type in the months before you refinance, and aim to apply for a new loan when the interest rates are low. Getting a good deal on your new loan can make it easier to manage your debt and avoid making late payments.
- Get your credit in shape before refinancing: Even if you had a good credit score to begin with, further improving your score will get you access to loans with better interest rates and terms.
- File all your loan applications within a short time period: Although a single hard inquiry won’t have much impact on your credit, too many hard inquiries can be damaging. Thankfully, credit scoring models ignore additional hard inquiries made within the same period (14 or 45 days, depending on the model), so making all your refinancing applications within this period will minimize the damage from your credit applications. 7
Tips for refinancing your mortgage
When you refinance your mortgage, it’s important to keep making payments on your old account until the refinancing process has finished. Otherwise, you may incur late payments, hurting your score.
It’s also important to look beyond your new loan’s interest rate. Refinancing a mortgage usually comes with upfront costs, closing costs, and monthly fees, so be sure to take into account all of these expenses when assessing the total cost of refinancing.
For example, take note of the following expenses that come with taking out a new mortgage: 8
- Appraisal fees
- Origination/application fees
- Property taxes
- Government taxes
- Title insurance
- Homeowners insurance
Bear in mind that even with a lower interest rate, you may end up paying more on your loan overall if you have a much longer repayment period. It’s a good idea to use a repayment calculator when comparing loan offers with your current mortgage.
Tips for refinancing your car
Before you refinance your auto loan, double check that you won’t face any prepayment penalty fees for paying off the loan early.
It’s also worth noting that some lenders won’t offer refinancing until a certain amount of time has passed since you took out your original car loan, so make sure that you meet their requirements.
Once you’ve done that, follow these tips to get the best refinancing deal on your auto loan:
- Calculate your overall repayment amount: A longer term may lower your monthly payments, but you could end up paying more overall because you’ll have to pay interest for longer. Make sure refinancing will actually save you money before you commit.
- Watch out for scammers: Do your research before signing up for a loan with a new company. The Federal Trade Commission recently issued a warning about auto loan refinancing scams to help borrowers avoid losing money to fraudsters.
In most cases, lenders will be more likely to approve your application if your car is still worth more than the amount you owe on it.
Tips for refinancing a personal loan
You can refinance a personal loan the same way you can refinance other types of loans. One added benefit is that you also have the option to use your new loan to pay off other debts you have, an approach known as debt consolidation.
By getting a personal loan with a lower interest rate than the rate on your other debts, you may be able to repay the debt faster because more of your money will be going toward the original loan amount and less will be going toward interest. Moreover, with fewer accounts to manage, you may be less likely to miss payments.
Tips for refinancing your student loan
Refinancing may make sense if you have private student loans. This is because private student loans usually have higher interest rates and fewer benefits than federal student loans.
When you refinance your student loans, a private lender pays off your existing student loans and replaces them with a single new loan, often with a new interest rate and repayment schedule.
If you’re looking into refinancing a student loan, all of the advice above applies. Review your loan’s terms carefully to make sure you’ll actually save money and that you’re not losing out on any benefits or protections that your new lender doesn’t offer.
What to do after refinancing
When you refinance, it’ll usually take around 30 to 60 days for the new loan to show up on your credit report. However, it could take up to 90 days in some cases. 9
The most important thing for you to do after refinancing is to consistently make on-time payments toward your new loan until you’ve fully paid it off. If refinancing leaves you with extra cash each month, consider putting it into a savings account so that you can cover your bills in the event of a financial setback.
It’s also a good idea to check your credit reports and credit score regularly to make sure your new loan is being reported correctly and that your credit recovers if refinancing caused a drop in your score.
You can get a free copy of each of your credit reports from the three major credit bureaus (Experian, Equifax, and TransUnion) at AnnualCreditReport.com. If any of the details on your new loan are incorrect, then dispute the errors immediately to prevent them from affecting your credit score.