Is refinancing bad for your credit? – Councilor Forbes
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Refinancing a mortgage, car loan, or other debt can be an effective way to access a lower interest rate or lower your monthly payment. However, refinancing can hurt your credit, so it’s important to understand the process and the consequences before using the strategy to manage your debt.
We’ll explain how refinancing works, how it can impact your credit score, and when it can be a good option.
What is refinancing?
Refinancing is the process of taking out a new loan to pay off the debt on the original loan, thereby changing the terms of the loan agreement. By refinancing a loan, qualified borrowers can access lower interest rates and lower their monthly payments by extending the term of the loan. Refinancing can also help consumers consolidate multiple loans into one streamlined payment.
Therefore, refinancing can be a great option if your credit score has improved since you applied for the original loan or if your financial plans can benefit from consolidation. It can even be a useful strategy if you’re struggling to make higher monthly payments, although it will likely result in higher interest payments over the life of the loan.
How Refinancing Can Lower Your Credit Score
Refinancing a loan can lower your credit score in three main ways:
- Hard credit check on the credit report. When looking for the best refinancing deal, lenders usually assess your creditworthiness by performing a credit check. If you rely solely on the prequalification process, it can be limited to smooth credit checks that don’t hurt your credit score. However, some lenders subject applicants to serious credit checks that stay on credit reports for two years and can result in a score drop of up to five points.
- Several loan requests. Each time you apply for refinancing from a different lender, the firm credit request will be reflected on your credit report and your score may go down. Fortunately, you can limit this by applying to all lenders within a short period of time, preferably within 14 to 45 days, depending on the rating model.
- Account closed. Refinancing a loan results in the initial closure of the loan account, which is reflected on your credit report. Ultimately, the impact of closing an account varies depending on the size and age of the account, so keep that in mind when considering refinancing.
When should you refinance a loan?
In general, it’s best to refinance a loan if your credit rating has increased significantly or if interest rates are lower than the first loan. However, even if you have a good credit rating, the ideal time to refinance a loan may vary depending on the type of loan.
When to refinance a mortgage
The best time to refinance a mortgage is when it saves you money or lowers your monthly payments. Under good market conditions, refinancing can help you save interest in the long run, but it can also help you eliminate a Federal Housing Administration (FHA) loan with high mortgage insurance premiums. Likewise, if you need to tap into the equity in your home, refinancing your mortgage is a great way to do it.
Keep in mind, however, that refinancing a mortgage comes with closing costs, including origination fees, appraisal fees, title insurance, and credit reporting fees. These fees often represent between 2 and 6% of the total loan amount.
Plus, refinancing a mortgage usually involves extending payments over a longer period of time. While this will reduce the amount you pay each month, it does mean that interest will accrue for longer. If you are considering mortgage refinancing, use a mortgage refinance calculator to determine the breakeven point.
If you’re unsure if it’s time to refinance your mortgage, work with some of the best mortgage refinance lenders to see how much you could save.
When to refinance a student loan
The best time to refinance a student loan depends on whether it is a federal or private loan. For example, refinancing a student loan usually makes more sense for private student loans because they do not enjoy the benefits of federal student loans. That said, there are several situations in which you may want to work with a student loan refinance lender:
- Your interest rates are high and / or variable, so you could earn unpredictably high interest in the future
- Your credit score has improved enough to qualify for a more competitive interest rate
- You will benefit from a lower rate which will save you money over the life of the loan
- Your student loans are private, so you won’t be sacrificing any federal loan programs like Income Based Repayment or Public Service Loan Forgiveness (PSLF)
- Interest rates are lower than they were when you originally applied for the loan
When to refinance an auto loan
Refinancing a car loan can make sense if you have the option of accessing lower interest rates than when you originally financed the vehicle. This may be the case if interest rates have come down or if you have financed the car through a dealership where the most competitive rates were not offered. Likewise, if your credit score has increased since you bought the car and you have an established record of consistent and on-time payments, you may simply be entitled to a better rate than you originally did.
Beyond accessing a better interest rate, refinancing can reduce your monthly automatic payment by spreading the repayment over a longer period of time. However, like refinancing other types of loans, this approach can increase the amount of interest you pay over the life of the loan. Also, keep in mind that your current car loan may impose a prepayment penalty which may increase the overall cost of refinancing.
In general, it’s best to refinance an auto loan if your car is still worth more than the outstanding balance on your current loan. Lenders are more likely to extend refinancing under these circumstances, but that’s not always the case, especially given how quickly cars depreciate.
When to refinance a personal loan
As with other types of loans, it is best to refinance a personal loan if your credit score has improved since the original loan was processed and you are likely to receive a better interest rate. Refinancing can also be an appropriate strategy if you need to reduce your monthly debt service or if you want to consolidate several personal loans into one lower interest rate loan. Here are some scenarios where refinancing a personal loan can make sense:
- Your credit rating has increased since the loan was originally issued
- You have an annual variable percentage rate (APR) and want to refinance yourself into a fixed rate loan
- Your income has decreased and you need to reduce your monthly debt service
- You want to avoid a future lump sum payment
- You are comfortable paying the lender’s application and origination fees
- You want to pay off your loan sooner by refinancing yourself into a shorter term loan
If you plan to refinance a personal loan or other debt in the near future, take steps to build your credit so that you are more likely to qualify for a competitive interest rate.
Next Steps After Refinancing a Loan
The process of refinancing a loan itself may seem complicated, but getting approval from the lender doesn’t mean your job is done. Once you’ve refinanced your loan, be sure to keep paying off your original loan until the process is complete. Then continue to make on-time payments on the new refinanced loan until it is paid off.
It can also be helpful to continue to monitor your credit score after the refinancing process is complete. Your score will likely drop, but that’s normal and the associated credit inquiries will naturally disappear from your credit report after two years. To protect your credit profile, simply confirm that there are no more inquiries on your report than necessary and review the details of the new loan to make sure they are updated in accordance with the refinance terms.
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