Refinancing means replacing an existing loan with a new loan. People sometimes do this to get better interest rates or more favorable loan conditions. But you should know that refinancing can also hurt your credit score temporarily. In this article we’ll look at how refinancing works to help you decide if it’s a good option for you.
Here’s what we’re going to cover:
- How refinancing works
- How refinancing can hurt your credit score
- Is loan refinancing right for me?
- What should I do after refinancing a loan?
- Oportun: Affordable lending options designed with you in mind
Key takeaways
- Refinancing a loan means replacing your existing loan with a new one. You might refinance to get a better interest rate or lower payments.
- You can refinance personal loans, auto loans, student loans, mortgages, and other types of loans.
- Refinancing can hurt your credit score temporarily, but good credit habits can bring it back up again.
How refinancing works
Refinancing is the process of replacing an existing loan with a new loan. This could be a good choice for you if interest rates have dropped or your credit score has increased since you took out your loan. You may be able to save money on interest, reduce your loan payments, or get out of debt sooner. With a large loan like a mortgage, this can make a major difference in your financial situation.
It’s possible to refinance many types of loans, including:
- Personal loans
- Mortgages
- Auto loans
- Student loans
How refinancing can hurt your credit score
Refinancing can offer financial benefits, but it can also affect your credit score in several ways.
Hard credit checks
When you apply for a loan, the lender makes a hard inquiry, or hard credit check, to look at your finances and decide whether you’re a good risk. This can temporarily lower your credit score. Hard credit checks stay on your credit report for two years.
Your credit report shows information about your credit activity, including credit accounts, balances, and payment history. Your credit score is a number between 300 and 850 that gives businesses an idea of how likely you are to make payments on time.
Multiple loan applications
Applying for multiple loans will result in multiple hard inquiries. But if you group your loan applications into a short time period, usually from 14 to 45 days, most credit scoring models will consider these a single hard inquiry. This allows you to shop around for the best loan rates without harming your credit further.
Fewer accounts, less diversity
When you refinance, your old loan is paid off and closed. This could mean you have fewer open credit accounts and less diversity in your credit mix. Both these factors may lower your credit score slightly.
Is loan refinancing right for me?
Refinancing is a big financial decision, one you should consider carefully before taking this step. Here are some circumstances where it might benefit you to refinance a loan.
Your credit score has improved
With a higher credit score, you may qualify for lower interest rates or better loan conditions. If you’re a recent graduate, for example, you may want to refinance an expensive student loan after you’ve built up your credit.
Interest rates have dropped
Interest rates go up and down all the time. If interest rates have dropped substantially since you took out your loan, it could benefit you to refinance. This is especially true for large loans like mortgages. You might be able to save hundreds of dollars a month on housing costs.
You want to simplify your debt
Refinancing also lets you consolidate debt by paying off multiple loans with one larger loan. This can streamline your debt management. You’ll have fewer payments to remember, saving you time and helping you avoid late or missed payments.
You want to tap home equity
In most cases, you refinance to get lower interest or smaller payments. But if you hold a mortgage on your home, you could also take out a larger loan to pay it off and use the difference for other purposes, such as renovations or travel. This is called a cash-out refinance.
Equity is the difference between your home’s market value and the amount you still owe on your mortgage. You can think of equity as the portion of your home that you currently own.
Cash-out refinances are complicated transactions. Consulting a financial advisor can help you decide if cashing out your mortgage would benefit you.
What should I do after refinancing a loan?
Refinancing a loan can cause some temporary damage to your credit. Payment history is the most important part of your credit score, so be sure to make all your payments in full and on time. This can help bring your credit score back up. Keep paying your old loan until it’s been closed.
After you’ve refinanced, you’ll also want to avoid making any more credit applications for about a year. More hard inquiries can cause your credit score to drop again.
How will you know when your credit score has improved? Ask whether your bank or lender will allow you to view your credit score for free. Some websites such as Experian also offer this service, but you may have to open an account or pay a fee for it.
Oportun: Affordable lending options designed with you in mind
Now that you understand how refinancing a loan affects your credit score, you may want to know more about affordable lending options through Oportun. Visit our homepage to learn about:
- Personal loans
- Credit cards
- Secured personal loans
- And more!
Sources
Experian. How does refinancing affect your credit score?
Experian. What is a hard inquiry and how does it affect credit?
The Ascent. How does refinancing affect my credit score?
Bankrate. Cash-out refinance: How it works and when to do it
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