If you’re paying off a large amount of debt, you might consider refinancing to lower your monthly payments. Refinancing can often help you get a lower interest rate or better repayment terms, which means you pay less interest overtime.
But before you decide to refinance your mortgage, auto loan, or personal loan, it's important to consider how it might impact your credit score. No matter what type of loan you have, refinancing can cause your credit score to drop, so it’s not the best option for everyone.
What Is Refinancing?
When you refinance, it means you pay off an existing debt, and replace it with another loan. Usually, the new loan has more favorable terms so you end up paying less money in interest. Refinancing can also help you get a lower monthly payment, which can free up your money to invest, or put towards something else.
Most loans can be refinanced, but auto loans, home loans, and personal loans are the most common loans that borrowers refinance. You can also refinance credit card debt, but it usually involves a balance transfer and is a slightly different process than refinancing a traditional loan.
How Refinancing Can Lower Your Credit Score
When you refinance a loan, it will most likely have a negative impact on your credit score. There are several reasons why this can happen.
First, when you apply to refinance a loan, the lending company will run a hard credit check. They need your financial information to determine your interest rate and the amount of money you are eligible to borrow. Anytime you have a hard credit inquiry on your credit report, it will temporarily lower your credit score.
Also, most borrowers shop around to find the best possible interest rate for their new loan. This involves submitting multiple applications, and can have a much bigger impact on your credit score. For each hard inquiry on your credit report, your score can drop.
Another thing to consider is that your credit score is usually affected when you pay off a loan, even if you’re refinancing. Because you must first close out your original loan before the new one takes effect, you will probably see your credit score drop.
How long does a refinance hurt your credit score?
The good news is that your credit score won’t be permanently ruined if you decide to refinance a loan. A hard credit inquiry will only stay on your credit report for two years. After that time, the inquiry is removed.
However, your credit score should start to improve well before the two-year mark. Once you start making on-time payments on your new loan, your credit will probably start improving. While there is no specific timeline, you can usually expect your credit to rebound after one year of consistent loan payments.
How many times do they pull your credit for a refinance?
If you apply to refinance a loan, you might assume that the lending company only checks your credit score once. However, many people are surprised to learn that a lender is allowed to run a credit report up to three times.
In most cases, you can expect the lending company to check your credit at least twice—once when you first apply and again before closing. This is because the loan application process can sometimes take several weeks or months to be finalized. If your credit score changes during that time, it may affect your interest rate (positively or negatively).
While less common, lending companies can also choose to run a third credit check in the middle of the application process. You might experience this if you decide to adjust the loan terms after getting pre-approved.
For example, let’s say you apply for a $25,000 loan with a repayment period of 60 months. If you get approved but later decide you actually want to borrow $40,000, the lending company might decide to run a second credit report then, and a final time before closing.
Refinancing a loan can be a good option for borrowers who want to get more favorable loan terms, such as a better interest rate or a lower monthly payment. However, refinancing will most likely impact your credit score.
Although your credit will eventually rebound, it may take up to a year or longer. That could impact your ability to apply for other loans, buy an insurance policy, or open a new credit card.
Before you decide to refinance a loan, take some time to weigh the pros and cons. If you already have an excellent credit score, the temporary dip might not be something to worry about. But if you are actively working on rebuilding your credit, refinancing could set you back.