You can refinance your current loan for several reasons. While it may seem like the best option, refinancing is likely to lower your credit score temporarily.
Discover how refinancing impacts your credit, how to limit negative effects, and the refinancing process. We offer several refinancing tips to help you make this significant financial decision.
What Is Refinancing?
Refinancing is when you use a new loan to replace an existing loan. You can do this through the current lender and revise and replace the current terms of your credit agreement. Or you could take out a new loan to cover the current one, usually because the new terms are more favorable.
You might refinance for several reasons, often related to economic conditions. People generally refinance to improve their ability to repay the loan or to find more favorable terms. The types of changes made often include the following:
- Payment schedule: You may need to reduce or extend the repayment period.
- Interest rate: If interest rates drop, you might refinance to save on monthly payments.
- Reduce payment amounts: If you struggle to keep up with payments and need a respite, consider reducing the monthly payments, although this will likely extend the loan period.
Will Refinancing Hurt Your Credit?
Refinancing a loan can lower your FICO® Score and other credit scores, usually not too drastically. Whether you refinance your car, student, or personal loan, it will likely affect your credit score for these reasons:
- Credit checks: A soft credit check will leave your credit score unaffected, and this happens if you rely on the prequalification process. Alternatively, some lenders will insist on hard credit inquiries, which linger on your credit report for around two years.
- Multiple loan applications: When various lenders perform hard credit checks, especially over an extended period, each inquiry goes on your credit record. If you submit your applications simultaneously or at most within 14 days of each other, the requests only count as one inquiry.
- The original loan is closed: Your old loan may be closed instead of reworked, which results in a report of a "new" loan and signifies that you took on the obligation of new debt.
- It lowers the loan's age: Having older loans in good standing improves your credit score, as it presents a proven track record. Starting a new loan means you have to build this history from scratch.
Does Refinancing a Car Hurt Your Credit?
You may experience a temporary impact on your credit score when you apply for and receive an auto refinance loan. As vehicle loans are typically expensive, refinancing your car loan could benefit your financial health.
Does Refinancing a Loan Hurt Your Credit?
Refinancing a personal loan can hurt your credit depending on how many applications you submit and the number of hard inquiries lenders make. Generally, you want to find a new loan with a lower interest rate for long-term benefits.
Does Refinancing Student Loans Hurt Your Credit?
Refinancing is one of a few tips to pay off your student loans, and it is usually a smart move and will only briefly impact your credit. Rarely, refinancing could be detrimental to your credit score, though this is typically tied to missed payments once you have refinanced.
Who Should Refinance and When to Refinance?
Should you refinance? First, consider your unique financial and debt situation. Examining your credit history gives you insight into whether refinancing is a sound decision and if it is worth the potential savings. Three things you should consider are:
- Sufficient income: You must earn enough to prove you will keep up payments after the refinancing.
- A good credit score: This will allow you to negotiate refinancing terms and make you more appealing to lenders.
- Adequate equity or collateral: If your income faulters, lenders like to know that you can offer assurance, particularly for significant loan amounts.
When to Refinance
Refinancing is beneficial in specific circumstances. At other times, refinancing can be unfavorable if the additional fees are high or you cannot secure a lower interest rate. These refinancing tips describe times when it is likely a good idea:
- You need to decrease payments: Your income may have lowered, or other expenses have risen. In these cases, instead of defaulting on payments, refinancing can lower your monthly payments. Note that lower payments generally mean extended repayment periods and increased total interest paid.
- You want to shorten the term: Refinancing your loan to a shorter term will clear the debt sooner and reduce the total interest amount. This is a good idea if your budget allows for increased monthly payments.
- Your credit score has improved: If you have paid off other debts and have a low debt-to-income ratio, then you likely have a better credit score. With a higher credit score, you can typically receive lower personal loan interest rates and save money.
Does Refinancing Cost Money?
Certain loans exclude additional fees and make money on the annual percentage rate. Sometimes refinancing a car, personal, or student loan costs money, although the costs are often far less than your overall savings. Some refinancing costs include:
- Application fee
- Origination fee
- Termination fee
- Prepayment penalties
How to Refinance: 8 Steps
There are several steps to refinancing, and each financial institution differs slightly, so use the following refinancing tips as a guide.
1. Try to Achieve a Better Credit Score
When starting, know what credit score you need for a loan so you have a target. If you already have a good credit score, you will likely secure more favorable interest rates. You can improve your score by taking action, such as reducing your current utilization rate.
2. Pre-Qualify for a New Loan
Pre-qualifying leaves your credit score untouched. You can pre-qualify with multiple lenders to see potential rates and terms on a new loan.
3. Compare the Loan Rates and Terms
Next, compare the new loan offers to your existing one. Ensure the new rates and terms offer you the payment period, monthly amount, and interest rate you want.
4. Consider Any Refinancing Costs
The last thing you want is a surprise bill from either your current lender or the new loan originator for fees such as paying it off early and initiating the new loan. It is best to know about these, even though they tend to be minimal.
5. Apply for the New Loan
After choosing your new preferred lender, you'll complete an official application and provide all the necessary documentation. Most banks and lenders require proof of identity and income, at the least. The lender will do a hard credit check, which will impact your credit score slightly.
6. Use the New Loan to Repay the Original
After you receive the approval and the funds are in your bank account, use this money to honor your previous loan in full. For your convenience, some lenders may pay off your first loan directly.
7. Confirm the Original Loan Is Closed
Check your account to ensure the first loan's balance is gone, or if the loan is not with your bank, request confirmation that the account is closed to avoid any further fees or penalties.
8. Begin Payments on the New Loan
You can focus on the new loan and set up automatic, recurring payments from your account so you have one less thing to remember.
Want Other Options? Get a Personal Loan From Atlas Credit
Refinancing a loan is a big step in securing your financial and credit health. At Atlas Credit, we understand the decision ahead. Refinancing can mean short-term effects on your credit score, though there are often long-term benefits.
Consider applying for a personal loan with Atlas Credit today! Our online application process is swift and easy, allowing you to access funds even with low, bad, or no credit history. If you are in Oklahoma, Texas, or Virginia, visit one of our many locations to start your application.