If a high-interest loan is eating a hole in your wallet, you can often enjoy lower monthly payments and greater peace of mind by refinancing. However, you might be worried about its impact on your credit score.
Refinancing a loan can affect your credit score in several ways, but the effects are often short-lived compared to the financial benefits it can offer. Before you start the refinancing process, it’s essential to know what refinancing is, its benefits, and how exactly it can impact your credit score.
What is Refinancing?
Refinancing is the process of paying off your current loan with a new one. The new loan should have better terms and features, such as a lower interest rate. You won’t be free of your debt, but instead, your monthly payment to the new lender may be lower or you may have more of your payment go toward the loan principal, rather than interest.
Benefits of Refinancing a Loan
Refinancing may take some initial time and research, but it can pay off with several attractive benefits. People and businesses choose to refinance their loans for a wide variety of reasons.
- To save money. Most people refinance their loans to save money on interest. If you can find a new loan with a lower interest rate than your current one, you can often enjoy significant lifetime savings – particularly on long-term loans.
- To consolidate debt. If you’re paying a student loan, auto loan, home mortgage, and a credit card bill every month to different lenders, it can be difficult to make sure statements are paid in full and on time. Refinancing allows you to consolidate many of your bills into a single payment, which is especially helpful if the new loan has a lower interest rate.
- To adjust the loan term. If you need to extend your loan repayment term and make lower monthly payments, you can shop for a loan that fits your needs. You can also choose to shorten the loan term to get rid of your debt more quickly.
- To change the loan type. Refinancing can be a helpful tool if you’re unhappy with your current loan type. For example, you might find that a fixed-rate mortgage offers more protection than one with a variable rate if rates are currently low.
How Does Refinancing Affect Your Credit Score?
While refinancing can impact your credit score, most of its effects are short term. Here are the two main ways your credit might be affected throughout the refinancing process.
1. Refinancing Results in Hard Credit Inquiries
Each time you apply for a loan – including a refinancing loan – potential lenders may pull your credit, which may result in a hard inquiry on your credit report. Hard inquiries can lower your score by a few points, and multiple hard inquiries can have a more prominent effect.
If you want to shop around for the best rates for refinancing your current mortgage, you should submit all of your applications within 30 to 45 days, according to FICO®. During this period, certain kinds of loan inquiries are treated as a single inquiry that won’t put a significant strain on your score. However, some lenders still use older FICO models with only a 14-day span, so it’s best to keep your inquiries within this stricter timeframe.
But if you’ve already made multiple inquiries without following the guideline above, know that a hard inquiry’s influence on your score diminishes over time, so its effects should be short-lived. Generally, a hard inquiry will show on your credit report for two years, but will only impact your credit score for one year. You can monitor your credit to view the impact of past inquiries on your score.
2. Replacing Old Debt Reduces the Opportunity to Build Long-standing Credit
Did you know that the age of your loan factors into your credit score? Older, established loans that are in good standing are valuable in boosting your credit.
When you refinance a loan, your old loan is technically paid off by the new one. When you pay off your old loan, you replace a long-standing payment history with a new one. Even though the debt is the same, the new loan can make your credit score take a sudden hit. However, if you stand to save a lot of money in refinancing, such as getting a lower rate on a mortgage, the hit can be worth it.
When Should You Avoid Refinancing?
Refinancing can provide many advantages, but there are some instances where it may be better to hold off. For example, with a mortgage, perhaps you have a fixed-rate mortgage with a higher interest rate. To lower your interest rate, you might refinance and secure an adjustable-rate mortgage (ARM) with a lower interest rate right now. ARMs, however, may not retain that lower rate, so you may only reap the benefits temporarily.
You must also consider the fees associated with a refinance. Sometimes, those expenses cost more than the money you’d save. Also, if you’ve already paid off a large majority of your current loan, a refinance may not be cost effective.
Refinance Your Loan with PSECU
If you’re interested in refinancing a loan, you might have a few questions about the process. We’re here to help you explore your options.
We offer mortgage refinancing options and credit card balance transfers that allow you to enjoy low interest rates. Apply now to start saving on your loans, or contact us for more information about the best options for your situation.
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