Does Refinancing Student Loans Hurt Credit?
Understand how refinancing student loans impacts your credit score, from immediate changes to long-term effects, and learn how to manage it.
Student loan refinancing involves replacing one or more existing student loans with a new loan, typically from a private lender. People often consider this financial maneuver to secure a lower interest rate, reduce their monthly payments, or simplify their repayment by consolidating multiple loans into a single one. This process can offer significant financial advantages, but it is important to understand its potential effects on your credit score. This article explains how refinancing can influence your credit standing, from the initial application to the long-term management of the new loan.
How Credit Scores Work with Student Loans
Credit scores, such as the widely used FICO Score, are numerical summaries of your creditworthiness, primarily based on information in your credit reports. These scores are calculated using five main factors: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%). Student loans are a type of installment loan, similar to car loans or mortgages, and they are regularly reported to credit bureaus.
Making consistent, on-time payments on student loans builds a positive payment history, which is the most influential factor in your credit score. The total amount owed on these loans also impacts your score, as paying down debt generally benefits your credit. Student loans contribute to the length of your credit history, especially if they are among your oldest accounts, and they add to your credit mix by demonstrating your ability to manage different types of credit. Managing student loans responsibly before refinancing can positively influence these various credit score components.
The Immediate Impact of Refinancing
Applying for a refinanced student loan results in a hard inquiry on your credit report. A hard inquiry occurs when a lender checks your credit file for a loan application, and it can cause a small, temporary dip in your credit score, by a few points. While a single hard inquiry has a minor effect, multiple inquiries in a short period could signal higher risk. Hard inquiries remain on your credit report for up to two years, though their impact diminishes after about 12 months.
When a new refinanced loan is approved, it appears on your credit report as a new account. This addition can slightly lower the average age of your credit accounts, impacting your length of credit history. While this change is minor, a shorter average age of accounts can have a subtle negative influence on your score. Simultaneously, the original student loan accounts are paid off and closed as part of the refinancing process.
Closing older accounts, even if paid off, can reduce the length of your credit history and affect your credit mix. However, accounts closed in good standing remain on your credit report for up to 10 years and continue to be included in score calculations. The initial effects of a new account and closed old accounts are temporary, and responsible management of the new loan can quickly offset them.
The Ongoing Impact of Refinancing
The most significant and lasting effect of refinancing on your credit score stems from your payment history with the new loan. Consistent, on-time payments are important, as payment history accounts for 35% of your FICO Score and is influential with other scoring models like VantageScore. Each on-time payment reinforces a positive credit pattern, important for long-term credit health.
The balance of your new refinanced loan can influence your credit utilization, especially if the new loan amount significantly changes your debt profile. While credit utilization refers to revolving credit like credit cards, managing installment loan balances responsibly by reducing them over time can positively impact your score. A lower balance on your refinanced loan, relative to the original amount, can demonstrate effective debt management.
Over time, the average age of your accounts will begin to increase again as the new refinanced loan matures. Although old accounts remain on your report for a period, the new loan’s age will eventually contribute positively to this factor. The refinanced loan continues to contribute to your credit mix, maintaining a diversity of credit types on your report, which can support a healthy score.
Actions to Mitigate Credit Score Impact
To manage and potentially improve your credit score after refinancing student loans, consistent financial discipline is beneficial. Prioritize making all loan payments, including your refinanced student loan and any other debts, on time every month. Setting up automatic payments can help ensure you never miss a due date, which is the most important factor for your credit score.
Maintaining low balances on your credit cards is an effective strategy, as this directly impacts your credit utilization ratio, a significant component of your score. Aim to keep your credit card balances well below 30% of your available credit limit. Avoid opening numerous new credit accounts immediately after refinancing, as multiple new credit applications can trigger additional hard inquiries and further reduce the average age of your accounts.
Regularly monitoring your credit reports from the three major bureaus (Equifax, Experian, and TransUnion) is important. You are entitled to a free copy of your credit report from each bureau annually, and checking them can help you identify any inaccuracies or signs of identity theft. Correcting errors promptly ensures your credit score accurately reflects your financial behavior.