Does Refinancing a Loan Affect Credit Scores?

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Does Refinancing a Loan Affect Credit Scores?

Does Refinancing a Loan Affect Credit Scores?

Refinancing a loan can help you save money. You can spend less on your monthly payments, and you can even get down the total amount of interest you will pay in some cases.

Those reasons alone are enough to convince most people to take action. But what about your credit scores,  does refinancing affect your credit negatively?

 

A Small, Short/Term Hit

You will probably see a minor impact on your credit scores when you refinance.

That makes sense if you understand how credit scores work: you have applied for a loan, which usually dings your credit slightly. We will get into some details below, but a more important question is whether or not it matters.

Refinancing might substantially improve your financial situation. If it means your score goes down temporarily, should you not refinance?

 

The whole point of having good credit is to take advantage of the benefits in particular the ability to get better loans. So if you’ve got that ability, there are very few reasons not to use it.

 

When to Avoid Refinancing

At least two situations that come to mind when you might not want to refinance. However, you will have to use your own judgment, there might be other situations, and the scenarios below might not really be that bad.

 

You are about to apply for a large or important loan: if you are getting ready to ask for an important loan such as a loan to purchase a home, think twice before refinancing.

You don’t want to lower your credit scores in that situation cause you might end up with a higher interest rate  and you might even get denied. Example, it doesn’t make sense to save a few bucks refinancing your, relatively small, auto loan if it means you will get a higher interest rate on your, relatively large,  home loan.

 

Wait until your important loan is approved to refinance the less important loan. The same is true if you are going to refinance multiple loans: start with the one that benefits you the most, and work your way down from there.

 

The new loan is not really better: another reason to avoid refinancing is that you might end up in a worse position than you were in previously. You might be able to get a lower interest rate or monthly payment, but what’s the tradeoff?

 

If you refinance into a new loan, you will often extend the term of the loan; it will take you longer to pay it off, and the payments at the beginning of the loan will be mostly interest, this is especially dramatic with longer term loans, if you only have 15 years left on your mortgage, and you refinance to a 30 year mortgage. While it may looks like you got a better deal, you might end up paying more in interest if you switch loans. Run the numbers to make sure refinancing makes sense.

 

You might also find that you refinance into a less friendly loan.  Example, if you refinance from federal student loans to a private student loan, you will give up the benefits of federal loans. Likewise, refinancing a loan that you used to purchase a home might increase your risk if you fail to re-pay, by turning it into recourse debt.

 

Again, given your situation, you might want to refinance a loan, even if it will affect your credit or increase your risk. You will have to evaluate the big picture to decide what is best

 

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