At a Glance

Refinancing can be a smart financial move, either to secure a lower interest rate or to save money by reducing the length of a loan. However, it’s essential to understand how refinancing might affect your credit score before you move forward with this process. Generally, refinancing will generate an inquiry on your credit report; this may cause a few points dip in your score, but typically such temporary drops recover within a few months and don’t have long-term effects.

On the other hand, doing due diligence, understanding the terms of any contracts, and staying up to date on timely payments during and after a refinance can demonstrate fiscal responsibility, which will likely raise your credit score in the long run. Understanding exactly how refinancing affects your credit score is key when considering this decision.

In this article, you’ll learn:

What is refinancing?

Refinancing is obtaining a new mortgage to replace an existing one. It can be used for various purposes, such as to lower monthly payments, shorten the loan term, change from an adjustable rate to a fixed-rate mortgage, tap into home equity, or consolidate debt.

During the refinancing process, you will apply for a new mortgage and, if approved, use the funds from the new loan to pay off your existing mortgage. The new mortgage will have different terms and conditions, including a new interest rate, loan term, and monthly payment.

Refinancing can be a good option for homeowners who want to improve their financial situation. Still, it’s essential to consider refinancing costs, including fees and closing costs, before deciding. It’s also good to compare offers from multiple lenders to ensure you get the best terms and rates available.

How refinancing affects your credit?

Refinancing your mortgage can impact your credit score, as the process typically involves multiple credit inquiries and changes in your debt-to-income ratio. A single credit inquiry can have a small and temporary effect on your credit score, but multiple inquiries can result in a more significant impact. Additionally, increasing your debt through cash-out refinancing or debt consolidation can increase your debt-to-income ratio and potentially lower your credit score. On the other hand, if you can lower your monthly payments and pay off debt through refinancing, it can positively impact your credit score over time. Overall, the effect of refinancing on your credit will depend on your financial situation and the specifics of the refinancing process.

1. Hard credit inquiries

A hard credit inquiry, also known as a hard pull, occurs when a lender or financial institution reviews your credit report as part of a loan or credit application. When you refinance a loan, a hard credit inquiry will be conducted as part of the loan application process.

Hard credit inquiries can temporarily negatively impact your credit score, typically lowering it by a few points. The exact impact depends on a variety of factors, including the overall health of your credit history and the number of hard credit inquiries you have recently had.

While a single hard credit inquiry may not significantly impact your credit score, multiple hard credit inquiries in a short period can have a greater effect. To minimize the impact on your credit score, it’s a good idea to limit the number of hard credit inquiries you have and to compare offers from multiple lenders before choosing to refinance.

Learn more: Hard Credit Inquiry

2. Multiple loan applications

Multiple loan applications, also known as rate shopping, can impact your credit score when refinancing. Each time you apply for a loan, a hard credit inquiry is conducted as part of the loan application process.

When you rate shop for a loan, multiple hard credit inquiries can occur in a short period, which can harm your credit score. The exact impact will depend on various factors, including the overall health of your credit history and the number of hard credit inquiries you have recently had.

To minimize the impact on your credit score, it’s a good idea to limit the number of loan applications you have and compare offers from multiple lenders within a short time, typically 14 to 45 days. This is because credit bureaus recognize that you are shopping for the best loan rate and will typically count all inquiries quickly as a single inquiry.

3. Closing an account

Closing an account when refinancing can impact your credit score in several ways. Here are a few ways that closing an account can affect your credit:

  • Length of credit history: Closing an account will shorten your average credit history, which can have a negative impact on your credit score.
  • Credit utilization ratio: Closing an account may increase your credit utilization ratio, the amount of credit you use compared to the amount available. This can have a negative impact on your credit score if it causes your credit utilization to exceed 30% of your total credit limit.
  • Mix of credit: A mix of different types of credit, such as a mortgage, auto loan, and credit card, can help boost your credit score. Closing an account can reduce the mix of credit you have, which may have a negative impact on your credit score.

When should you consider refinancing?

You should consider refinancing when interest rates are lower than what you are currently paying or if your financial situation has changed and you want to lower your monthly payments, shorten your loan term, change from an adjustable-rate to a fixed-rate mortgage, tap into home equity, or consolidate debt. Refinancing can also be a good option if you want to switch from a government-backed mortgage to a conventional mortgage or vice versa. However, it’s essential to consider refinancing costs, including fees and closing costs, before deciding. It may be beneficial to compare offers from multiple lenders and consult a financial advisor or mortgage specialist to determine if refinancing is the right choice.

1. Refinancing mortgages

Refinancing a mortgage involves obtaining a new loan to replace an existing mortgage. This can be done for various reasons, such as to lower monthly payments, shorten the loan term, change from an adjustable rate to a fixed-rate mortgage, tap into home equity, or consolidate debt.

During the refinancing process, you will apply for a new mortgage and, if approved, use the funds from the new loan to pay off your existing mortgage. The new mortgage will have different terms and conditions, including a new interest rate, loan term, and monthly payment.

Learn more: How to Refinance a Home Mortgage?

2. Refinancing a personal loan

Refinancing a personal loan involves obtaining a new loan to pay off an existing personal loan. This can be done for various reasons, such as to lower the interest rate, reduce monthly payments, or change the loan term. During the refinancing process, you will apply for a new loan and, if approved, use the funds from the new loan to pay off your existing personal loan. The new loan will have different terms and conditions, including a new interest rate, loan term, and monthly payment.

Learn more: Can You Refinance a Personal Loan?

3. Refinancing auto loans

Refinancing an auto loan involves obtaining a new loan to repay an existing one. This can be done for various reasons, such as to lower the interest rate, reduce monthly payments, or change the loan term.

Benefits of Refinancing

The benefits of refinancing your mortgage can include:

  • Lower monthly payments: Refinancing to a lower interest rate can result in lower monthly payments, freeing up cash flow for other expenses.
  • Shorter loan term: Refinancing to a shorter loan term can result in higher monthly payments, but you will pay off your mortgage faster and save on interest over the life of the loan.
  • Change from an adjustable-rate to a fixed-rate mortgage: If you have an adjustable-rate mortgage (ARM), refinancing to a fixed-rate mortgage can provide stability and predictability, as your interest rate will remain the same for the life of the loan.
  • Cash-out refinancing: If you have built up equity in your home, you can use cash-out refinancing to tap into that equity and receive a lump sum of cash. This can be used for various purposes, such as home improvements or debt consolidation.
  • Debt consolidation: Refinancing can consolidate high-interest debt, such as credit card balances, into a single loan with a lower interest rate. This can result in lower monthly payments and make debt repayment more manageable.

These are some of the benefits of refinancing, but the specific advantages will depend on your financial situation and goals. It’s a good idea to consult with a financial advisor or mortgage specialist to determine if refinancing is the right choice for you.

Rebuilding your Credit after Refinancing

Rebuilding your credit after refinancing can be done by following a few simple steps:

  • Make timely payments: Late payments can significantly impact your credit score, so making payments on time is essential. Set up automatic payments or reminders to ensure you never miss a payment.
  • Keep your credit utilization low: Your credit utilization ratio, which is the amount of credit you use compared to the amount available, should be kept below 30%. High utilization can indicate that you are overextended and may negatively impact your credit score.
  • Monitor your credit report: Regularly check your credit report for errors and dispute any inaccuracies. You can request a free credit report from each of the three major credit bureaus once per year.
  • Limit new credit applications: Every time you apply for new credit, it can result in a hard inquiry on your credit report, which can temporarily lower your credit score. Limit new credit applications and only apply when necessary.
  • Pay down debt: High debt levels can lower your credit score, so it’s crucial to work towards paying down your debts. Start by paying off high-interest debt first, then work your way down the list.

FAQs

The amount of time it takes for your credit to recover after refinancing depends on several factors, including the number of credit inquiries during the process and any changes to your credit utilization or payment history.

Typically, a single credit inquiry will have a minor and temporary effect on your credit score, and the impact should dissipate within a few months. The effect may be more significant if you have multiple credit inquiries, but it should still be temporary.

Your credit score should recover quickly if you have a good payment history and a low credit utilization ratio before and after refinancing. On the other hand, it may take longer for your credit to recover if you have a history of late payments or a high credit utilization ratio.

Generally, it’s a good idea to monitor your credit score regularly and make timely payments on your debts to maintain a good credit standing and help your credit recover after refinancing.

The number of times your credit will be checked during the refinancing process can vary, but it is typically done at least once by the lender you are applying with. Some lenders may also check your credit with a credit bureau during pre-approval. If you use multiple lenders to compare rates and terms, each lender may also review your credit, which can result in various inquiries.

Numerous credit inquiries can have a small impact on your credit score, but the effect is typically temporary and will dissipate over time. It’s a good idea to keep credit inquiries to a minimum when shopping for a refinance loan to minimize the impact on your credit score.

Refinancing is not always a good idea for everyone. Whether refinancing is a good option for you depends on several factors, including your current interest rate, the terms of your existing mortgage, your credit score, and your financial goals.

If you have a high-interest rate on your existing mortgage and can secure a lower rate by refinancing, it can result in substantial savings over your loan. It can also be a good option if you want to change the terms of your mortgage, such as switching from a variable to a fixed rate, or if you want to consolidate debt.

However, refinancing can also come with costs, such as appraisal, closing, and loan origination fees. It’s important to consider these costs and calculate if the potential savings from refinancing outweigh the costs over the life of the loan.

A good credit score to refinance typically ranges from 720 to 760 or higher. This is considered a “good” to “excellent” score and can help you secure better interest rates and loan terms. However, some lenders may still approve refinancing for those with lower scores, and the minimum requirements can vary. It is important to check with multiple lenders to compare your options and find the best deal.