Key takeaways:
- Refinancing can temporarily hurt your credit score, but it may be worth it to save money in the long run.
- You can minimize the impact refinancing has on your credit by maintaining a high credit score, utilizing prequalification tools, and applying when interest rates drop in the market.
- After refinancing, make all payments on time for your new loan to help your credit score bounce back quickly.
When you loan money, it’s ideal to borrow with the best and most affordable terms possible for your budget. However, accessing low-interest rates or lower monthly payments may not have been possible when you initially got a loan. In that case, refinancing could be worth considering since it might save you a significant amount of money—especially if there’s a lot of time left in the loan.
But before you jump into refinancing something as important as a personal loan, auto loan, or mortgage, it’s essential to understand how it can affect your credit. Whether you’ve decided to refinance or are still weighing your options, here’s what you need to know in terms of how it can impact your credit standing.
Does refinancing hurt your credit?
Refinancing will initially hurt your credit score because it requires a hard inquiry and will affect the number of credit accounts on your report. However, this financial strategy can lower your monthly payment and save you on interest. In this case, it may help your debt become easier to pay off and might help increase your score, which could ultimately better your financial position in the long run.
Eventually, your credit score will likely improve as you pay off this new loan. But, when it comes to refinancing, it’s necessary to consider all the ways it can negatively impact your credit too.
How refinancing can lower your credit score
There are a few ways refinancing can lower your credit score:
- Hard credit check. Any time you apply for a new line of credit, a lender must check your credit report with a hard pull or inquiry. This part of the process allows lenders to weigh your creditworthiness for approval on a loan. Once authorized, your credit score typically drops around 5–10 points. After 2 years, the initial inquiry falls off and is no longer factored into your credit score.
- Multiple loan applications. To find the best loan options possible, you can have your credit pulled at numerous financial institutions. Normally, applying with different lenders counts as a hard inquiry each time, which can decrease your score. To minimize this, inquire with all of them within a short time frame. Most credit scoring models will treat them as 1 inquiry if they’re all done within a 14 to 45-day window.
- Closing an account. When you refinance, the original loan closes. This reflects on your credit report, but the impact it has on your score depends on the size and age of the account. If the closed account was in good standing, this could lessen the hit to your credit score.
Common types of refinancing that can impact your credit
If you have a current loan that doesn’t have a decent interest rate and your credit score has gone up, it may be in your best interest to refinance now, even if it will slightly hurt your credit. Refinancing could help you pay off your loan quicker, which could then improve your credit score in most cases.
It’s crucial to know how common types of refinancing can factor into your credit.
Refinancing a personal loan
You can refinance a personal loan. This is often a smart move if your credit score has gone up or rates have lowered since your original loan was processed. You should also consider refinancing a personal loan if you want to avoid paying a balloon payment or switch from a varied interest rate to a fixed one for more financial stability.
You might want to lower your monthly debt or consolidate several personal loans into one larger loan with lower interest. With more money going toward the loan amount and less toward interest, you could then pay off your debt faster.
When refinancing a personal loan, there are some main unfavorable factors to look out for:
- Being unable to qualify for better interest rates or terms
- Fees or penalties outweighing your savings
- Preparing to finance another purchase that could decrease your credit score
Pro tip: Many personal loan providers offer a free way to check your eligibility online. For instance, you can prequalify for a personal loan through Upstart within minutes and view loan terms available for you.
Refinancing an auto loan
When you refinance an auto loan, you could gain access to a lower interest rate if current rates have fallen, your credit score has gone up to better qualify, or if you financed the car through a dealership where competitive rates weren’t offered. Refinancing can also lower your monthly auto payment by spreading out repayment over a longer amount of time.
It’s best to refinance a car loan if your car is worth more than the outstanding balance of your current loan, as cars quickly depreciate in value. Lenders can take this into account when determining to extend your payoff.
Refinancing a mortgage
Usually, it’s most beneficial to refinance your mortgage when it can help lower your monthly payments. Typically, refinancing extends payments out over a longer period of time, which results in paying more interest in the end. If refinancing moves you from an FHA-backed loan to a conventional loan, you may also be able to eliminate mortgage insurance premiums. Depending on the terms you receive, refinancing your mortgage could give you much more wiggle room in your budget.
It’s important to note that when you refinance a mortgage, you’ll also come across closing costs, like origination fees, or costs for a new appraisal, title insurance, and taxes. These costs commonly make up between 2% and 5% of the total loan amount.
How to prepare your credit for refinancing
If you’re worried about how refinancing may affect your credit, there are a few things you can keep in mind for better preparation. Planning ahead can get you in a position where refinancing won’t negatively affect your credit score and overall financial health.
- Maintain a high credit score. Keep a close eye on your credit report and, if necessary, get your credit score into shape before refinancing. Without a good credit score, you won’t be able to effectively negotiate refinancing terms. Make sure you’re paying your current loan on time and dispute any errors you may find in your credit report.
- Prequalification tools. Rather than taking a chance at your credit score dipping and getting denied a loan, use a prequalification tool beforehand. This can give you a better idea of your chance of approval, along with what loans and terms you may be eligible for.
Pro tip: If you’re considering refinancing a personal loan, check your rate through Upstart to get personalized terms. With a soft credit pull, our model considers more than your credit score when determining your loan terms, such as your education¹ and employment.
- Plan accordingly. Monitor the average interest rates on the market for your loan type before you refinance. Aim to apply for a new loan whenever the interest rates are lowest. Getting a better deal on your new loan can make it easier to manage your debt and regrow your credit.
Next steps after refinancing
Your score is there to get more affordable loans with terms that work best for you. Take advantage of your credit and refinance if it makes sense for your financial situation.
Looking ahead after refinancing, focus on proving your ability to repay the new loan on time and rebuilding your credit score. It should be relatively easy to increase your credit to the number it was before you refinanced your loan in a matter of a few months. Your credit score may even improve if you’ve handled the loan well enough.
As long as you take preventative measures and know what to expect, you shouldn’t struggle with the refinancing process. At the end of the day, you should look forward to having more money in your wallet.
¹Neither Upstart nor its bank partners have a minimum educational attainment requirement in order to be eligible for a loan.
Won't affect your credit score¹