If you’re looking for a way to lower interest rates, reduce your monthly instalments, or consolidate your debt, refinancing your loans can be a great option. Applying for a new loan to repay an existing one can help create some breathing room in your budget, whether it’s a home, car or personal loan.
While refinancing can prove beneficial in the long run, it could have temporary setbacks, such as affecting your credit score.
There are several ways refinancing could affect your credit score, including:
The overall duration of your credit history is considered while calculating your credit score, meaning older accounts can sometimes be better for your credit score. While refinancing, your long-standing credit account will be replaced by a new one, which may cause a slight dip in your credit score.
While applying for any credit, lenders will submit a formal request for your credit file. This is known as a hard inquiry, and it may hurt your credit score by 5 or 10 points every time it is conducted. So the more applications for credit you submit, the more inquiries on your credit report will be made, and your credit score may fall.
The level of credit score needed to refinance can vary from lender to lender and depend on the type of credit you're borrowing. However, typically, a score above 650 is generally considered 'good' while applying for a loan.
When refinancing, your credit score may get hurt, but this impact is often temporary. By checking on a few things, you can ensure that any effect refinancing has on your credit score doesn’t affect your long-term credit history.
For instance, you can:
While your refinancing application is still processing, it’s a good idea to ensure you maintain all your financial commitments, including paying repayments on your current loan on time. Some people often wait until the refinancing process is complete and pay the outstanding amount. You might miss a monthly payment if you do this, so it may be better to make payments until your current loan is closed. Continue making timely repayments even after a new loan replaces your old one. This will help establish a consistent repayment history on the new loan and potentially help increase your score.
After applying for refinancing, consider avoiding any other credit applications for maybe a year or so. This could help maintain a positive credit score because with each new inquiry your score may continue to fall. Consider only inquiring about a credit application when you really need it. This could help improve your credit score, so the next time you apply for a loan, you’re more likely to be approved.
Refinancing could be one of the best ways to save money, such as when more competitive loan offers are available, whether with lower interest rates or fewer fees. You may also want to refinance your mortgage to access your equity or refinance when you want to consolidate your debts.
To find a good deal for refinancing your existing loan, start with some research of your own and compare interest rates, features, and payment terms first-hand. This will help you understand the terms and find a lender that fits your requirements.
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This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.
