Manage Money

How Does Refinancing Affect Your Credit Score?

How Does Refinancing Affect Your Credit Score?

Do you have an exorbitant loan which is getting too risky to handle? A heavy loan or a debt can be frightening and overwhelming. Refinancing could be a viable option for you. You might have taken a loan a very long time ago and things might have changed ever since. Refinancing allows you to move the debt to a better place and improve the terms of your loan. It can reduce your interest rates and lower monthly payments.

What is Refinancing?

Refinancing is an extremely convenient process which allows you to replace an existing loan with a new one. This new loan must have better terms and should help you improve your finances. You can pay off your current debt with the new loan. Let me elaborate the steps of refinancing to give you a clearer picture:

  1. You have an existing loan that you wish to improve

  2. Find a lender offering better loan terms

  3. Apply for the new loan

  4. Pay off the existing debt using the new loan

  5. Make payments on the new loan till it is settled

  6. Save some money on the interest

Most loans such as mortgages, auto loans, student loans and personal loans have refinancing options.

Refinancing: Its Effects on Your Credit Score

Can refinancing affect your credit scores? Maybe. Maybe not. Read on to know more.

Balance Inquiry

When you apply for a new line of credit, including refinance loans, lenders will run a check on your credit report, which results in hard inquiries. Hard inquiries reduce your credit score by a few points. The influence of a hard inquiry on your credit score decreases over time. You can monitor your credit report to gauge the impact of hard inquiries on your credit score. You can use the Intelligent Finance Tool of mymoneykarma to keep a track of your credit report.

Account Closure

As you refinance a loan, your initial loan account will be closed. You will start over with a new loan - this loan has a new opening date and no payment history. Some credit bureaus will consider your closed loan while calculating your average credit age, whereas some bureaus won't. Similarly, some credit bureaus might consider your payment history of the closed loan while making your credit report. However, it will receive much lesser importance than an active account. If you are planning on closing very old accounts, refinancing could be a sudden blow to your credit score.

Credit Mix

In case you are planning on refinancing to settle multiple lines of credit, you may want to stop and reconsider. The moment you refinance, all those credit accounts will be closed. Not only will it reduce your average credit age, but it will also mar the diversity of credit accounts that you earlier had. The variety in the types of your accounts can help you secure a better credit score. Refinancing might not be a great idea in this domain.

Conclusion

However, this doesn't necessarily mean that you must totally avoid refinancing. If situations call for it, you must accede. You can’t do much to speed up the aging of your loan or your payment history. Be patient. These factors will gradually improve over time. Additionally, Your new refinance loan will also be added to the number of your total accounts as well as to your average credit age. The impact might be less, but something is better than nothing.

To Sum Up

So, we're back to square one: does refinancing affect your credit score or not? There is no indisputable answer to this. Be smart, consider your credit situation and think twice before making a final decision. Go for refinancing only if it makes sense. It might or might not affect your credit score, but take my word for it - the ripples will not be very severe. Do the calculations well in advance. Use your Grey matters before taking the plunge.

Get your free Credit report that cost Rs 1200 for FREE

1. Build your Credit Score

2. Reduce your Current Borrowing / EMI Costs