Does Refinancing Affect Your Credit Score?

Refinancing involves replacing an existing loan with a new one, typically to secure more favorable terms such as a lower interest rate or a reduced monthly payment. While it can offer significant financial advantages, the process of refinancing does have an impact on your credit score. This influence is not always negative and can change over time, depending on various factors reported to credit bureaus.

Initial Credit Inquiry

Applying for a refinanced loan initiates a process that includes a credit check, which appears on your credit report as a “hard inquiry.” A hard inquiry occurs when a lender reviews your credit report to make a lending decision. This differs from a “soft inquiry,” which might happen when you check your own credit score or when a lender pre-screens you for an offer, as soft inquiries do not affect your credit score.

A hard inquiry can cause a temporary, minor dip in your credit score, often by five points or less. The impact is usually minimal and short-lived, with scores often recovering within a few months, assuming other credit behaviors remain positive. Hard inquiries typically remain on your credit report for up to two years, but credit scoring models generally only consider them for the first 12 months.

When shopping for a refinanced loan, multiple inquiries for the same type of loan within a specific timeframe are often treated as a single inquiry by credit scoring models. This “rate shopping” window can vary, with FICO models often grouping inquiries made within 14 to 45 days as one event, and VantageScore models typically considering a 14-day period. This approach prevents your score from being penalized multiple times for seeking the best loan terms. However, applying for different types of loans, such as a mortgage and an auto loan, within a short period may result in separate inquiries.

Changes to Your Credit Report

Refinancing introduces several changes to your credit report that can influence your score. When a new loan is opened, and an old one is closed, credit scoring factors such as the average age of accounts, credit mix, and payment history are affected.

Average Age of Accounts

The average age of your accounts is a component of your credit score, reflecting the length of time your credit accounts have been open. Opening a new, young account, such as a refinanced loan, can lower the overall average age of all your credit accounts, which might have a slight, temporary negative effect on your score. The older your credit accounts, the better it is for your score, as it demonstrates a longer history of responsible credit use.

Credit Mix

Your credit mix, which is the diversity of account types on your report, also plays a role in your score. Having a blend of revolving credit (like credit cards) and installment loans (like mortgages or auto loans) can be viewed positively. Refinancing usually involves replacing one installment loan with another, so it may not significantly alter your credit mix, but it does add a new instance of an installment account.

Payment History

The payment history of your original loan remains on your credit report, which is beneficial if you consistently made on-time payments. Accounts closed in good standing can stay on your credit report for up to 10 years, continuing to contribute to your positive history. The new refinanced loan establishes its own payment history. Timely payments on this new loan will build a positive record, which is the most significant factor in credit scoring. If the refinance involves consolidating other debts, it could reduce reported debt levels on revolving accounts, potentially improving the credit utilization ratio.

Ongoing Credit Management

After the refinance process, proactive credit management is important to maintain or improve your credit score. These actions help ensure the positive impact of refinancing is maximized over time.

Make Timely Payments

Making timely payments on your new refinanced loan is important. Payment history is the most influential factor in credit scoring, accounting for a significant portion of your score. Consistent, on-time payments demonstrate financial responsibility and contribute to building a strong credit profile over the life of the loan. Setting up automatic payments can help ensure payments are never missed.

Avoid New Debt

Avoiding new debt immediately after refinancing is a sound strategy. Taking on substantial new credit obligations can negatively impact your debt-to-income ratio and potentially lead to increased credit utilization if new revolving credit is used. Lenders assess your ability to manage existing and new debt, so minimizing additional borrowing allows your credit profile to stabilize after the refinance.

Monitor Credit Reports

Regularly monitoring your credit reports for accuracy after the refinance is complete is a practical step. This ensures that the new loan is reported correctly and that the old loan is appropriately marked as closed. Reviewing your reports helps identify any errors or discrepancies that could negatively affect your score, allowing you to dispute them promptly.