Does Refinancing Hurt Your Credit?

There are several good reasons to refinance loans, whether it’s a mortgage, auto loan or personal loan. Refinancing could possibly help you score a lower interest rate or restructure the loan so you have more time to pay it off. If you’re thinking of refinancing, you might be wondering how it will affect your credit score. It does have an impact, but it isn’t as dire as you might think.

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The Short Answer: Does Refinancing Hurt Your Credit?

Refinancing your loan does have some impact on your credit, but it might be a stretch to say that it “hurts” your credit. The process of applying for a loan refinance can cause your score to drop a few points, but if all your accounts remain in good standing, this alone shouldn’t hurt you much in the long run.

How Refinancing Can Affect Your Credit Score

When you refinance a mortgage, car loan or personal loan, it can impact a few different factors that contribute to your credit score.

First, since refinancing involves taking out a new loan, it can impact your average age of accounts. The length of your credit history accounts for 15% of your credit score, and getting a new account will decrease the average age of your accounts. But as you make payments on your new refinanced loan over time, you’ll regain the credit age advantage. 

Opening new credit accounts can affect your credit score as well. This factor makes up 10% of your score, and opening multiple new accounts in a short period of time can have an especially heavy impact here, as it may appear to lenders like you’re desperate for additional lines of credit because you’re living beyond your means. So if you’re refinancing, be mindful about other accounts you apply for, and prioritize only those that you truly need.

Hard Credit Inquiry

When you refinance, it will result in a hard credit inquiry, where the lender reviews your credit report and other financial information to decide whether you can afford the new loan. This hard credit pull usually causes your score to dip by a few points, but the drop isn’t permanent. In the long term, the bigger potential issue is not paying your new loan off in time.

How Much Can Refinancing Lower Your Credit Score?

The exact impact depends on your credit profile, but for most borrowers, refinancing causes a relatively small drop. The hard inquiry alone typically accounts for less than 5 points, though the total impact could be closer to 5 to 10 points when you factor in the new account and closure of your existing loan. Either way, the effect is temporary, and consistent on-time payments are the fastest way to recover.

How Long Does the Credit Impact Last?

Hard credit inquiries can stay on your credit report for up to two years, but they typically only affect your score for 12 months or so. If you stay on top of your loan payments, your score will usually recover in a few months.

When Refinancing Can Actually Help Your Credit

Refinancing’s impact on your credit score doesn’t have to be dire, but it is important to be aware of before you take out a new loan. But on the flip side, there are some aspects of refinancing that can actually be helpful to your credit and overall financial health.

Lower Monthly Payments

Many people make the move to refinance a loan so they can get a new term with lower monthly payments. This can make it easier to stay on top of your debt without missing any payments, and since payment history accounts for 35% of your score, this alone can go a long way toward helping your credit. 

Debt Consolidation

If you’re refinancing so you can roll multiple personal loans into one single loan, this can also improve your payment history. With just one payment to keep track of rather than several, there’s less risk of falling behind and damaging your payment history. 

Reduced Credit Utilization

Depending on your situation and reasons for refinancing, there could be a positive impact on your credit utilization as well, and this accounts for 30% of your credit score. 

This would come into play if you’re refinancing to consolidate debt and using your new loan to pay off existing debt, such as a credit card balance. In that case, your overall credit utilization would decrease. But if you’re simply refinancing a loan so you can get a better interest rate or pay off the existing balance over a longer period of time, your overall credit usage won’t be directly impacted.

Tips to Minimize Credit Score Impact When Refinancing

A small dip from a hard inquiry is unavoidable, but there are some steps you can take to keep the overall impact of refinancing to a minimum.

• Shop for rates within a short window: Lenders (and the credit bureaus) understand that a key part of finding the best loan is comparing your rates. While your credit score will suffer a slight ding from a hard credit inquiry when you apply for a refinance, all applications within a short window, usually 14 to 45 days, will be grouped together rather than counted as individual inquiries. Some lenders let you check your rates with a soft pull that won’t affect your score, which can also be useful. 

• Continue making payments: Any small dip to your credit score from a hard credit inquiry is nothing compared to the negative impact of falling behind on your loan payments. When you refinance, make sure your new loan payment is truly manageable for your budget so you can stay current.

• Avoid opening new credit accounts: Minimize the decrease in your average age of accounts by holding off on opening other new accounts around the time you process your refinance. 

• Check your credit beforehand: Know your credit score situation before you apply for a refinance. You can get free copies of your Experian credit report and FICO score from freecreditreport.com.

When Refinancing Might Not Be Worth It

Refinancing a loan is usually only worth it when it saves you money or makes your repayment terms more manageable. Refinancing a mortgage usually involves paying a closing cost of 3% to 6% of the loan principal, for instance, so you’ll want to make sure that the amount you’re saving with a lower interest rate is substantial enough that you’ll actually come out ahead in the long run. Refinancing auto loans and personal loans usually don’t require closing costs, but there could be origination fees, so look out for those as well.

Refinancing also might not make sense if you’re planning to pay off your existing loan soon, since you’ll pay less interest if you repay the loan in full sooner rather than later. Make sure you run the math and take all costs into account before making a final decision.

FAQs

Is refinancing bad for credit?

Refinancing isn’t necessarily bad for your credit, though it will drop your credit score by a few points in the short term. This effect is usually short-lived, though, so if you stay on top of payments, it won’t tank your credit score.

How much does a refinance hurt your credit?

A refinance usually drops your credit score by a few points, often less than 5. 

What does credit refinancing mean?

Credit refinancing refers to replacing high-interest debt, such as a personal loan with a high APR, with a new loan that has a lower interest rate.

Sources

• Official Clearview Federal Union website

• Official Federal Reserve website

• Freecreditreport.com

• Official MyFICO website