Does Refinancing Affect Your Credit Score?

Refinancing is the act of paying off a current loan by taking out a new one. You might choose to refinance if you think it’ll help you get a lower monthly rate, or else pay less interest in the long term. Refinancing can be a useful tool for anyone paying off a long-term loan, such as a home, car, or student loan, especially as your financial circumstances change and you find you are able to afford to pay more or less per month. But does refinancing affect your credit score? And if so, does it improve it, or hurt it?

The effect of hard inquiries

Applying for refinance loans, as with applying for any loans, involves creditors running your credit report, creating new “hard inquiries.” These inquiries typically lower your credit score by a few points. Although the effect of one inquiry is negligible, the refinancing process usually leads to several such inquiries.

If you want to minimize the harm that these hard inquiries do to your credit score, there are steps you can take.

Be sure to get all your applications in during a short time period: fourteen to forty-five days. Additionally, keep your inquiries consistent in terms of your requested loan and what kind of companies you are applying to. Some credit score models will consider all inquiries made during a short period of time to be just one inquiry, especially if all the requests seem to be similar. It’s better to apply for twelve credit cards over the course of a month than to apply for six over the course of a year.

The effect of closing accounts

Refinancing involves closing an old account (the old loan, that you are paying off through the refinancing process), and opening a new account (the new loan, which you are taking out in lieu of the old one). Closing your account will not affect your credit score immediately. Since the old account is immediately replaced with a new one, the amount of money made available to you will not change, meaning that your credit will not be jeopardized by your spending ratio.
However, in the long run, it can have an effect because it will likely lower your mean account age. Successfully holding loans for multiple years, while paying regularly, looks a lot more impressive on a credit report than paying money to a loan that you have only had out for a short while. This change will not be immediately noticeable, because closed, paid-off accounts remain in your credit for ten years after being closed. For those ten years you will have the benefits of an old account being factored into your credit. After that time, however, the old account will go away, and your credit will likely drop as a result.

On the plus side

That said, if refinancing a loan looks like a good decision, then it probably is. While your credit score will likely drop, the damage will be slight and clear up over time, especially if you take the proper steps. Additionally, getting a good deal on a loan can help your credit if it puts you in a position where the ratio of your monthly pay to the amount of money you are paying off in loans is good.

The takeaway

It’s never a bad idea to think about your credit and how your actions might affect it. That said, there are other important factors that weigh on your finances, and one of those factors is how much money you are paying in loans. If refinancing is going to help you save money, or if it will make it easier for you to pay off those loans, then it is a worthwhile choice to make.

Reasons to Refinance Your Mortgage (continued)

mark teta mortgage documentation

In my last blog post we started discussing the various reasons that a homeowner would look into refinancing a mortgage. We touched on the conversions between adjustable rate and fixed rate mortgages, and the shortening of the mortgage’s term. In this post, we’ll touch on the remaining (common) reasons for refinancing.

Getting A Lower Interest Rate

As with the switch between adjustable rate and fixed rate mortgages, the goal is to save money via interest rates on the loan. When seeking a lower interest rate, it’s always necessary to switch between rate-types. In an environment where interest rates are low, mortgage holders (with fixed rates) may seek out refinancing to obtain another, fixed-rate mortgage with a lower rate. The general rule is to only seek out refinancing if there is an opportunity to reduce the interest rate by 1-2%, anything less will not be worth the upfront costs of the refinance.

 

Debt Consolidation or Accessing Equity

These are some of the most common reasons that mortgage holders will consider refinancing, but they are also the reasons that carry the most risk, from a personal finance perspective.

Some mortgage holders will look to refinancing in order to access their home equity.  The justifications for this move will vary. Some will use the equity to pay off remodeling, which can increase the value of the house, or to purchase more property, which can be a great investment. Others will use the equity to to cover large personal expenses, or pay off other debts.

Other mortgage holders will refinance to try to consolidate their debts; the idea of reducing high interest debt with lower interest debt makes sense on paper. However, many people who are refinancing for this purpose alone will not necessarily be saved from their high-interest (ie: credit card) debt forever. It’s likely that they will accrue more high interest debt with the available credit the refinancing has allowed them.

 

For a great breakdown of how mortgage rates are quoted, view this video by Khan Academy: