Refinancing is an option for homeowners who have a mortgage. Refinancing is also available for auto or car loans, personal loans, and students. Business loans can also be refinanced.
All major banks and financial institutions as well as private lenders will be willing to refinance short to long-term loans. Refinancing is a completely legitimate financial instrument for borrowers who wish to take advantage of better rates. It is also an option for lenders to help borrowers take advantage of better propositions while ensuring they get repaid. Often, refinancing is necessary because a high rate of interest may make repayment difficult for a borrower. This is especially true for homeowners who have a mortgage.
The Basics of Refinancing
Most borrowers have either of the two purposes of refinancing: obtaining a lower rate of interest or cashing in on the equity. Some borrowers want to do both. It should be noted that refinancing is not a second mortgage. Refinancing can primarily be about a lower rate of interest or different terms of repayment. It could offer both. It is always better to refinance if you think from the perspective of a borrower when one can reduce the rate of interest, opt for a longer period of repayment or accomplish both. However, refinancing may have an impact on the credit history so if you are conscious of the ripple effect on your credit score then you may want to know the possible repercussions.
Does Refinancing Have Any Effect on Credit Score?
Refinancing gets you a new loan. You use it to repay the old loan. Whatever sum of money you are yet to repay along with the accrued interest gets repaid using the money you borrow through refinancing. The old loan, which could be a mortgage or home loan, car loan, personal loan, student loan, or business loan, is repaid and closed. You have a new loan that you start repaying. You may save money every month due to a reduced rate of interest. You may also pay less every month if the repayment term is relatively longer given the fact you have borrowed a much smaller sum than the original loan. It is possible to capitalize on the built-up equity on a property or asset. In such a scenario, a line of credit using equity as collateral or some other arrangement may be at play.
Refinancing does have an effect on credit score but to what extent shall depend on many factors. It is possible the effect would be nominal. It is equally likely that the effect would have a devastating impact on your credit history. Let us take a close look at the different ways refinancing will affect your credit score.
Hard Inquiries Affect Your Credit Score
The first impact will be due to the hard inquiry. Whenever you apply for a loan, regardless of whether it is financing or refinancing, the lender will run a credit check. This credit check is not the usual act of looking up your score or assessing your history. The lender will run the credit check with the intention of approving or rejecting your request. This hard inquiry has an adverse effect on credit scores. Usually, the impact is negligible.
However, you are unlikely to contact only one lender. You are perhaps going to shop around and apply to multiple lenders. This will lead to multiple hard inquiries. If these inquiries are initiated in a short span of time, say all lenders have conducted a hard inquiry and checked your credit history in a fortnight to forty-five days, then these will be clubbed as one. The credit rating bureaus understand that you are rate shopping and hence the multiple hard inquiries. Your credit score will have an impact but only proportionately to one hard inquiry.
If several hard inquiries are conducted over a period of many months then these would be considered separately and hence your credit score would take a beating. It is possible you would lose a hundred points if five to ten hard inquiries are made over a period of twelve months.
New Loans Affect Your Credit Score
Every time you take a new loan, your available credit or creditworthiness reduces. This is not a bad thing as long as you keep repaying existing loans or do not have any other loans at the time of applying. Since you are considering refinancing, you already have a loan and that is yet to be repaid completely. Hence, the new loan would reduce your creditworthiness. The old loan you have will be closed and gradually removed from your credit history. This takes several years. The closed account will no longer be factored into your credit score. How you repay the new loan will have a stronger influence. The timely repayments of your old loan will not matter as much when it is closed as they would have if it was still open.
The new loan will find a place on your credit report. This may have a positive impact since there is one more entry and it is not a bad one since you have not defaulted on a repayment. However, any misadventure with the closing of the old loan and beginning to repay the new loan can have a negative impact on your credit score. You would not get refinanced immediately. You would need to continue repaying the old or existing loan till the time you get approved for the new loan, the money gets disbursed and the old loan is closed after full payment. You should keep paying the old loan till it is closed and not think that the refinancing will take care of because you have been approved. Also, you must immediately start repaying the new loan from the day it is supposed to be repaid. Delay will have an instant negative effect on your credit score.
If your old mortgage or some other loan is almost at the end of its term, do not consider refinancing. If you cannot save a substantial sum of money with refinancing, then you may consider continuing to repay the original loan.
If you’re looking at refinancing, it’s important to know what impact it could have on your credit score and finances. Consult with a financial expert to decide if a refinance is right for you.