Before making a big financial decision, it is important to understand how this can affect your credit score. Of course, if you are going for refinancing, you are wondering if doing so could harm your credit.
Refinance usually doesn't hurt your credit score much, but the answer isn't always black and white. Regardless of whether you are still thinking about your options or have already made your choice, we have explained what you need to know about refinancing below.
What is refinancing?
Refinancing is defined by taking a new loan to repay the balance of your existing loan. How you approach a refinancing decision depends on whether it's a home, car, student loan, or personal loan. Since refinancing essentially replaces an existing debt obligation with another debt obligation on different terms, it's not an easy decision.
If you are concerned about how refinancing will affect your credit score, keep in mind that there are several factors that will determine whether or not it will affect your credit score. However, the three most important factors are:
1) Having a solid credit score
You are unable to negotiate refinancing terms without adequate credit.
2) Earn sufficient income
If you can't prove that you can keep up with the loan payments after refinancing, then you can't.
3) Proof of sufficient equity
You also need to ensure that payments continue to be made if your income cannot cover the costs. It is recommended that when refinancing a home, you hold at least a 20 percent stake in a property.
How is refinancing hurting your credit?
Refinancing seems like a good option, but how exactly is refinancing hurting your credit? In short, refinancing can temporarily lower your credit score. As a reminder, the top credit-related factors that affect creditworthiness are credit inquiries and changes in credit balances and terms.
Whenever you refinance, lenders run a hard credit inquiry to check your credit score. Hard credit inquiries usually lower your credit scores by a few points. Avoid making multiple new inquiries by using smart shopping tactics. It is also helpful to have all of your applications within a 14 to 45 day period.
Note that credit inquiries made during a period of 14 to 45 days may count as one inquiry in the calculation of your scores, depending on the type of loan and the rating model. Regardless, your balance will not be permanently damaged as the effects of a tough query on your balance will decrease over time anyway.
Changes in loan balances and terms
The extent to which changes in loan balances and terms will affect your creditworthiness will depend on whether your refinanced loan is reported to the credit bureaus. Lenders can report it as the same loan with changes or as a brand new loan with a new open date.
If your refinance loan is reported as a new loan, your creditworthiness can be more seriously affected. This is because a new or recently opened date usually means that it is a new loan commitment, which will affect the score more than simply changing the terms of the existing loan.
How do common types of refinancing affect your balance?
Refinancing could help you pay back your loans faster, which could actually improve your credit score. However, there are several factors to consider when refinancing different types of loans.
Refinancing a Mortgage
Refinancing a mortgage has the greatest potential impact on your creditworthiness and can definitely affect your FICO score. How can you keep refinancing from affecting your bankroll too much? When buying mortgage interest, focus your loan inquiries on a 14 to 45 day window. This helps avoid multiple hard requests. You can also work with your lenders to avoid them having to manage all of your balances, which can lower your credit score.
If you are unsure when to refinance your mortgage, do the research to get the best timing. For example, refinancing your mortgage at low interest rates might be a viable option for you – but it depends on your situation. Remember, losing your records of paying an old mortgage on time can affect your creditworthiness. Disbursement refinancing could also have an adverse effect.
Refinancing a car loan
When you are figuring out whether it is worth refinancing your auto loan, do your due diligence. When you refinance a car loan, you take out a second loan to pay off your existing car debt. In some cases, refinancing a car loan can be a smart move that can lower your interest rate or your monthly payments. For example, if you are dealing with a wrong car loan, you may want to consider refinancing.
However, there are many factors to consider before making a decision to refinance car loans. If the loan has a longer term arrangement with a lower monthly payment, will you be satisfied with it? Because the longer it takes for your car to pay off, the more likely it is that it will lose value.
Refinancing student loans
When refinancing student loans, a lower interest rate could translate into significant savings. Regardless of whether you've built your own strong credit rating or are benefiting from a co-signer, refinancing can be worthwhile.
Typically, you can refinance both your federal and private student loans. In general, refinancing your student loan shouldn't be detrimental to your financial future in the broadest sense. Be aware, however, that refinancing from a federal loan to a private loan will affect the repayment options available to you. Since federal loans can offer significantly better repayment options than private loans, this should be considered before making your decision.
When the cost of borrowing is low, securing a lower interest rate is possible
Credit scores can drop due to credit checks by lenders
When your credit score has improved significantly, you can refinance for a better interest rate
The creditworthiness can be negatively influenced by the conclusion of an earlier loan for refinancing
By refinancing a loan, you can cut costs in both the short and long term
Refinancing may incur fees. It is therefore essential to carry out a cost-benefit analysis
This will prevent the refinancing from affecting your credit
If you plan ahead, you can empower yourself to ensure that the refinance will not adversely affect your creditworthiness and overall financial health.
Read your credit reports carefully and make sure there are no errors that could prevent your loan application from being approved at the best possible price. Always stay one step ahead of mistakes so you still have time to address them. As long as you are taking preventative steps in the refinancing process to save time and money, you shouldn't be struggling with refinancing.
If refinancing makes sense for your situation, then you shouldn't worry about it affecting your creditworthiness. This may not be the most ideal situation, but it is extremely common and usually relatively easy for your creditworthiness to recover.
If you find that your new refinance loan is making alarming changes when you do your credit check, reach out to your creditor or consider a dispute settlement. As long as you prioritize your financial health through smart decision-making and budgeting, refinancing shouldn't hurt your creditworthiness in the long run.