Is Refinancing Bad For Your Credit? – Forbes advisor
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Refinancing a mortgage, car loan, or other debt can be an effective way to access a lower interest rate or reduce your monthly payment. However, refinancing can affect your creditworthiness, so it is important to understand the process and consequences before using the debt management strategy.
We’ll show you how refinancing works, how it can affect your creditworthiness, and when it might be a good option.
What is refinancing?
Refinancing is the process of taking out a new loan to pay off the debts of the original loan, thereby changing the terms of the loan agreement. By refinancing a loan, qualified borrowers can potentially access lower interest rates and reduce their monthly payments by extending the loan term. Refinancing can also help consumers consolidate multiple loans into a single, streamlined payment.
Accordingly, refinancing can be an excellent option if your credit rating has improved since you applied for the original loan, or if your financial plans can benefit from a consolidation. It can even be a helpful strategy if you’re struggling to make higher monthly payments – although doing so will likely result in more interest being paid over the life of the loan.
How Refinancing Can Lower Your Credit Score
Refinancing a loan can lower your credit score in three ways:
- Hard credit check on credit report. When looking for the best refinancing terms, lenders usually do a credit check to assess your creditworthiness. Relying solely on the prequalification process may be limited to gentle credit checks that won’t affect your credit score. However, some lenders subject applicants to harsh credit inquiries that remain on credit reports for two years and can result in a drop in scores of up to five points.
- Multiple loan applications. Every time you apply for refinance from another lender, the harsh credit request will affect your credit report and your score may go down. Fortunately, you can limit this by applying to all lenders within a short period of time – preferably within a 14- to 45-day window, depending on your scoring model.
- Closed account. Refinancing a loan will result in the closure of the original loan account, which is reflected in your credit report. Ultimately, the impact of an account closure will vary based on the size and age of the account. So keep that in mind when considering refinancing.
When should you refinance a loan?
In general, it is best to refinance a loan when your creditworthiness has improved significantly or the interest rates are lower than when you first took out a loan. Even if you have a good credit rating, the ideal time to refinance a loan may vary depending on the type of loan.
When to Refinance a Mortgage
The best time to refinance a mortgage is when it will save you money or reduce your monthly payments. In the right market conditions, a refinance can save you interest in the long term, but it can also eliminate a Federal Housing Administration (FHA) loan that comes with high mortgage insurance rates. Even if you need to tap into your home equity, refinancing your mortgage is a great way to do it.
Be aware, however, that refinancing a mortgage comes with closing costs, including a commitment fee, valuation costs, title insurance, and credit report fees. These costs often add up to between 2 and 6% of the total loan amount.
In addition, refinancing a mortgage usually involves extending the payments over a longer period of time. While this lowers the monthly amount, it means that the interest accrues longer. If you are considering mortgage refinancing, use a mortgage refinancing calculator to help you determine your breakeven point.
If you are unsure whether now is a good time to refinance your mortgage, work with some of the best mortgage refiners to see how much you can save.
When should you refinance a student loan?
The best time to refinance a student loan depends on whether it is a federal or personal loan. For example, refinancing a student loan for private student loans usually makes more sense, as they are not associated with the advantages of a federal student loan. However, there are several situations you may want to partner with a student loan lender:
- Your interest rates are high and / or floating so you can accumulate unpredictably high interest rates later
- Your credit rating has improved enough to qualify for a more competitive interest rate
- You will qualify for a lower interest rate that can save you money over the life of the loan
- Your student loans are private, so you don’t have to sacrifice federal loan programs like income-based repayment or Public Service Loan Forgiveness (PSLF).
- The interest rates are lower than the original loan application
When should a car loan be refinanced?
Refinancing a car loan can make sense if you have the option to access lower interest rates than when you originally financed the vehicle. This can be the case if interest rates have fallen or if you financed the car through a dealer who did not offer the cheapest prices. If your credit history has increased since you bought the car – and you have consistent, on-time payments – you may just be able to qualify for a better rate than you originally got.
In addition to getting access to a better interest rate, refinancing can lower your monthly car payment by spreading the repayment over a longer period of time. However, as with refinancing other types of loans, this approach can increase the interest you pay over the life of the loan. Also, keep in mind that your current car loan may impose a prepayment penalty, which can add to the overall cost of refinancing.
In general, car loan refinancing is best when your car is worth even more than the balance of your current loan. Lenders are more likely to extend refinancing in these circumstances, but that’s not always the case – especially given the rapid depreciation of automobiles.
When should a personal loan be refinanced?
As with other types of credit, if your credit history has improved since the original loan was processed and you are likely to get a better interest rate, it is best to refinance a personal loan. Refinancing can also be a suitable strategy if you need to lower your monthly debt service or want to combine several personal loans into one lower-interest loan. Here are some scenarios in which refinancing a personal loan can make sense:
- Your credit score has increased since the initial loan was granted
- You have a variable annual percentage rate (APR) and want to refinance yourself with a fixed rate loan
- Your income has gone down and you need to lower your monthly debt service
- You want to avoid an upcoming balloon payment
- You can conveniently pay the lender’s application and creation fees
- You want to pay off your loan sooner by refinancing yourself into a loan with a shorter term
If you plan on refinancing a personal loan or other debt in the near future, take steps to build your credit so that you are more likely to qualify for a competitive interest rate.
Next steps after refinancing a loan
The process of refinancing a loan itself can seem complicated, but getting the lender’s approval doesn’t mean your job is done. After refinancing your loan, make sure you keep making payments on your original loan until the process is complete. Then you pay off the new, refinanced loan on time until it is paid off.
It can also be helpful to keep monitoring your creditworthiness after the refinancing process is complete. Your score will likely go down, but this is normal and the corresponding credit requests will naturally drop from your credit report after two years. To protect your credit profile, just make sure your report doesn’t have more hard inquiries than necessary and review the new credit details to make sure they are updated in accordance with the refinancing terms.
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