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Does Refinancing Affect Your Credit Score?
●July 12, 2021●5 minute read
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If you’ve been looking for a way to reduce your loan repayments, you might want to consider refinancing your loan. Sometimes, refinancing can end up securing you a better deal on a loan, with lower fees or more suitable terms. While it can be a useful tool for saving money, there are factors to consider before deciding if it’s right for you.
In this article, we dive into refinancing including how it affects your credit score, how it can be useful, and more things you should know before you submit that new application.
What is refinancing?
In a nutshell, refinancing is the replacement of an existing debt obligation with a new debt obligation, under different terms that might be more suitable for you. Essentially, you’re trading in your current loan agreement for a new, possibly better one.
To put it simply, refinancing is consolidating all of your debts. When you refinance, the new provider pays off your old loan, and you make the new repayments to the new creditor (hence why it is called refinancing).
It’s common to hear about refinancing a mortgage, but you can also refinance a personal loan or credit cards. Also known as a consolidation loan, refinancing allows you to streamline multiple debts, such as personal loans and credit cards, into one payment plan.
Can refinancing affect my credit?
The short answer is, yes, it will likely affect your credit score. Usually, refinancing causes your credit score to dip temporarily, due to closing the current credit account and applying for a new loan (both of which appear on your credit report). Additionally, submitting multiple applications can affect your credit score.
Closing a credit account shows on your credit report, and can have a negative impact on your credit score if it’s settled and only a portion of the debt was repaid. However, if the loan was repaid in full, closing a credit account should not impact your credit score.
Applying for a new account
Any new credit enquiry can impact your credit score, as the provider will likely conduct a credit check on you. This is what is known as a ‘hard enquiry’, which will show up on your credit report alongside any other time you have applied for credit.
More so if you don’t have a long credit history, applying for any form of credit can sometimes temporarily affect your credit score.
While submitting multiple applications to find the best deal might seem like a good idea, unfortunately, it will likely negatively affect your credit score. This is because submitting multiple credit applications will appear on your credit report, and could lead other lenders to believe that you are in financial distress and desperately need a loan (even if this isn’t the case). This is why it is best to enquire about different loan options available, without submitting applications until you find the most suitable loan for you.
If you do need to submit multiple applications, try to space them out as long as you can to avoid negative impacts to your credit rating.
When should I refinance my loan?
While refinancing can seem like an easy way to find a better deal, it doesn’t always end up being a better option overall. When considering refinancing, it’s important to consider the total amount of money you’ll end up saving, and whether this even ends up being the case.
According to Investopedia, the rule of thumb when deciding if refinancing is worth it for you is if you can reduce your interest rate by at least 2%. However, many lenders say 1% is enough incentive to refinance.
In order to give you a comprehensive idea of the factors you should consider before refinancing, these are the situations in which refinancing might or might not be suitable for you.
|When refinancing might be suitable
||When refinancing might not be suitable
|Your current rate isn’t competitive and there are lower rates available.
||Your break cost, being the cost of closing your old account, is too high.
|If you are refinancing a mortgage, refinancing could be suitable if the value of your home has increased and you want to access its equity.
||If you are refinancing a mortgage, the equity being less than 20% of the property’s value.
|Your financial or personal situation has changed and you need a different financial product to suit.
||Your income stream isn’t reliable or stable.
|Your personal loan or credit card debts are becoming difficult to manage, and you want to consolidate them.
||When refinancing a mortgage, if you’re planning to sell your property in the near future, it might not be worth it.
Can I refinance my loan if I have bad credit?
In short, you can refinance your loan if you have bad credit, but it might not be advisable. Especially if you are refinancing to find a better interest rate or loan term, you will be more likely to find a better deal with a good credit score.
If you’re looking for ways to improve a bad credit score, there are things you can do that should result in an improved credit score:
- Stay on top of any personal loan or credit card debt;
- Reduce your credit card limit (if possible);
- Make all of your credit payments (loans, credit cards, utility bills) on time;
- Consider consolidating your debts if it suits your financial situation;
- Reduce any new applications for credit (if possible);
- Avoid making multiple credit applications in a short period of time;
- Check your credit report for any errors or inconsistencies.
Unfortunately, a bad credit score doesn’t have a real way to ‘fix’ it, as it is a calculation based on all of your credit history. However, responsible management of credit products should reflect in your credit rating.
If you want to learn more about what your credit score means, check out our recent article. If you’re applying for a new personal loan, here are 5 tips to improve your chances of approval.
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Written by Rachel Horan
Rachel Horan is a Content Writer for Jacaranda Finance. Rachel has previously produced content for Brisbane City Council, Black & White Cabs, and Clubs Queensland. She has a Bachelor of Mass Communication with Distinction from the Queensland University of Technology.