When you swap out a current loan’s lender for a new lender, it’s a chance for a fresh start. Refinancing a loan — typically a mortgage, auto, or student loan — can make solid financial sense for several reasons. Most importantly, you’ll likely score a lower monthly payment, which will stretch your budget further. Ideally, the refinanced loan will also allow you to save on interest costs over the lifetime of the loan. Certain types of refinancing loans might offer you the opportunity to consolidate debt from other loans, or even extend access to cash for other expenses. As impressive as these benefits might sound, refinancing does come with its own set of risks. Depending on the type of loan, your decision to refinance could have several repercussions on your credit score. We took a look at the various effects of refinancing on your credit score to help you make your decision.
Before You Start
Check in with your credit report, just as you would when applying for a new loan. You’ll want to sit down and carefully review any recent additions to your report, as well as negative transactions or history. If you don’t recognize something in your report, now is the time to dispute the error. When your credit report is in solid shape, you stand to gain the most from refinancing — as you will be able to qualify for loans with more favorable terms and a lower interest. Even if you don’t spot a mistake, the credit report check-in provides some visibility into your current credit situation. You may want to continue to keep tabs on your credit report over the next few months, as you may notice some fluctuations during the refinancing process.
Each time you apply for a loan, the creditor will run your credit report. This results in what’s known as a “hard inquiry,” which will be classified as such on your credit report. Although hard inquiries might cost you a few points from your credit score, the impact is generally a slight one. If you plan to apply with multiple lenders to nail down the best possible rate, try to squeeze your rate-shopping into a short window of time, such as less than 45 days. Major credit scoring models may view the numerous inquiries as just one, provided they are done in a fairly compressed time period. That’ll lessen the total blow to your credit. Note that you might see a hard inquiry on your report for up to two years, but it will gradually lose its effect on your credit as time passes.
Losing Out on Older, Positive History
Part of achieving a solid credit score is the length of your credit history. When you switch lenders, however, you may shorten the average age of accounts — a critical piece of the credit score puzzle. Depending on the credit scoring model, your refinanced loan might be treated as a brand-new loan with zero payment history. If the payment history remains on the refurbished loan, it may not weigh as heavily in the overall score calculation. Either way, you’ll lose out on a healthy source of valuable credit score points — although you will be able to reverse this effect over time once you build back up a history of on-time payments to your new lender.
Your Debt Levels May Jump
Some people opt for a “cash-out refinance,” which allows them to borrow cash immediately. The amount of cash you borrow will be tacked on to the new loan amount. For example, if your mortgage is $250,000 and you borrow $25,000, your total loan amount will be $275,000. This can be a dangerous arrangement, as you’re ballooning your debt levels and increasing your overall credit utilization. As a result, lenders and creditors might view you as a riskier prospect in the future.
Your credit score is just one of the many concerns you may have when you are considering refinancing one of your major loans. Turn to us if you need an extra hand whipping your credit report into shape before a refinance. At Ovation Credit, we specialize in working with credit agencies and disputing inaccurate items quickly and efficiently. Contact us today for a free consultation and learn how we can help you.