Does Refinancing Hurt Your Credit Score?
Explore the nuanced ways refinancing can impact your credit score, detailing both immediate and lasting effects on your financial standing.
Refinancing a loan often appears as a beneficial financial strategy to secure better terms or lower monthly payments. Many individuals consider this option for mortgages, auto loans, or personal debts. However, a common concern arises regarding its potential impact on credit scores. While refinancing can indeed be a valuable tool, it may lead to both immediate and sustained effects on an individual’s credit standing.
Immediate Credit Score Drops from Refinancing
Applying for a refinanced loan typically initiates an immediate, though often temporary, dip in a credit score. This initial impact primarily stems from a hard inquiry. When a lender assesses a loan application, they perform a “hard pull” on a credit report to review an applicant’s creditworthiness. This action is recorded and can cause a small, temporary reduction in credit scores.
Multiple hard inquiries within a short timeframe for the same type of loan are often treated as a single inquiry by credit scoring models. This “shopping period” minimizes the cumulative negative effect on a score. Despite this grouping, opening a new loan account can also temporarily lower a score. This occurs because a new account represents new debt and a shorter credit history, which credit scoring models view with caution until a consistent, positive payment history is established.
How Refinancing Affects Credit Over Time
Refinancing can introduce sustained changes to a credit score. One significant area affected is the average age of accounts. When an older loan is paid off and replaced with a brand-new one during refinancing, the overall average age of a consumer’s credit accounts can decrease. Credit scoring models generally favor longer credit histories, so a shorter average age can negatively influence a score.
Refinancing can also alter a consumer’s credit mix, which refers to the diversity of credit types, such as installment loans and revolving credit. While a balanced mix is generally seen favorably, changing this composition can be interpreted differently by scoring models. The most substantial long-term impact on a credit score comes from payment behavior on the new refinanced loan. Missing or making late payments on this new obligation will severely harm the credit score, as payment history is a primary factor in credit scoring.
Credit Score Factors Impacted by Refinancing
Credit scores are determined by several factors. Payment history is the most significant factor, typically accounting for 35% to 40% of a FICO or VantageScore. When a new loan is established through refinancing, its payment history begins anew. Any missed payments on this new account will have a substantial negative effect on this crucial factor.
Amounts owed typically constitutes 30% to 30% of a FICO score and 20% to 34% of a VantageScore. Refinancing can change the total amount and types of debt. If a refinanced loan results in a higher overall debt burden or if revolving debt is consolidated but then re-accumulated, it can negatively impact this factor.
The length of credit history usually makes up 15% to 21% of a credit score. Closing an older loan and opening a new one during refinancing shortens the average age of accounts, which can be detrimental to this factor.
New credit activity accounts for approximately 10% of a FICO score and 5% to 11% of a VantageScore. Applying for and opening a refinanced loan is categorized as “new credit” activity, which credit models view with some caution due to the potential for increased risk associated with taking on new debt.
Credit mix, representing the diversity of loan types, contributes around 10% to a FICO score and is considered “highly influential” by VantageScore. While a healthy mix of installment and revolving credit can be beneficial, refinancing can alter this mix, and the impact depends on how the change is perceived by the scoring model.