In today’s economy of fluctuating interest rates, refinancing a loan can significantly lower your monthly payments, if you wait until a prime interest rate is available. Many people, however, are concerned about the effect a refinance can have on their credit rating. Will it seriously damage your credit in the long term? Will it affect your ability to get other loans and lines of credit in the future? Let’s take a look at how refinancing affects your credit score.
Does Refinancing Hurt Credit Scores?
What Refinancing Is
The first thing to understand when exploring this topic is, “what exactly is a refinance?” Refinancing is not simply applying a lower interest rate to your existing loan, though that is sometimes how it is painted. In essence, refinancing is the process of taking out a new loan at a lower interest rate and sometimes at a longer repayment term, which pays off your old loan. You then begin making payments on the new loan.
For example, if you have a car loan at 11 percent interest over six years, and three years in, you have an opportunity to refinance at 5 percent, you are essentially taking out a new loan that covers the balance of your old. This new loan will be at 5 percent interest. You may also have the option to take it out for three, six, or even nine years. The longer your repayment term, the lower your monthly payments will be.
About 10 percent of your credit rating comes from the kind of credit you have: student loans, mortgage debt, credit cards, personal loans and car loans all have different effects on your final credit score. The trick is to keep a good mix of different kinds of credit to show that you are reliable across the board. A new car loan adds to this mix and can actually help improve your overall credit score.
A strong history of paying back installment loans (which is essentially what a car loan is) by making timely scheduled payments is the best way to build good credit. Again, this can help your credit score so long as you stay on top of your payments.
However, underwater car loans — where you owe more than the car is worth — can be problematic. When you refinance, keep that in mind before you take a 3-year loan and extend it out to ten. This is the type of thing that can harm your credit. If you can lower your existing payment with a new loan at the same term and a lower interest rate, all the better.
Remember, too, that any time you ask for credit, this results in a hard inquiry on your credit score. When a potential creditor checks your score, it creates a temporary hit on your rating. If you’re shopping around for loans, each hit lowers your credit score on a temporary basis. Always keep this in mind.
In the end, refinancing your car can make good sense if you are careful about how you do it and you take care to stay on top of your monthly payments. Check out our auto refinance page, and give us a call to get started today!