Refinancing a loan or mortgage can be a great way to access lower interest rates and lower your monthly payments. But it can also ding your credit score. So how do you weigh the pros and cons?
Let’s start by getting clear on the basic terms.
What is refinancing?
Refinancing involves taking out a new loan to pay off the debt of the original loan. This process can help you lower your interest rate and extend your loan term. (That’s the period of time you’ll agree to make payments to pay off the loan).
Refinancing can also be used to combine multiple loans into one new loan, offering the convenience of one streamlined payment, along with the advantage of a new lower interest rate.
But here’s how refinancing can lower your credit score:
- Credit check: When you apply to refinance a loan, lenders do a hard inquiry on your credit history. This can temporarily lower your credit score, but it usually recovers as long as you continue to make payments on time, building a strong payment history.
- Applying to multiple loan applications: Each time you apply with a different lender, and incur another hard credit inquiry, your credit score takes another ding. To minimize this, try applying to different lenders within a short time frame. Most credit scoring models treat inquiries within a 14-day period as one inquiry. Some even extend that period to 45 days.
- Closing account- Refinancing will also result in the closure of your old loan, which ends its positive payment history and can lower your credit score. However, the impact is lessened if the loan was closed in a good standing.
Factors affecting credit scores.
Is refinancing a mortgage a good idea?
Refinancing a mortgage can help lower your monthly payments, which may be your largest expenditure each month. That can free up your budget month after month.
If your refinancing moves you from an FHA-backed loan to a conventional loan, you might also get to drop (or even eliminate) your mortgage insurance premiums. That can lower your monthly payments too.
But here’s another big factor: when you refinance, you’ll probably incur closing costs, like origination fees or paying for a new appraisal. Fees and costs like these that commonly come with a refinanced mortgage can range between 2% to 6% of the total loan amount.
A mortgage refinance also involves extending the terms of your loan, so your monthly payments will go down, but you may pay more in interest over the long run.
Is refinancing a car loan a good idea?
If you're thinking about refinancing your car loan, make sure the new loan actually saves money.
Refinancing a car loan can be a good idea under the following conditions:
- If the car has good resale value. Before you apply to refinance your auto loan, check the approximate value of your car. Several websites offer free estimates. If the car is worth less than what you owe on it, refinancing may be difficult to get.
- If interest rates are falling fast. If the current market conditions can deliver a lower rate, then refinancing may be the right way to go.
- If your credit score has gone up. If you’ve boosted your credit score in the 12 months since taking a loan, you may qualify for a loan with a lower interest rate.
Is refinancing a personal loan an option?
Yes! Personal loans can be refinanced. The goal should be to save money, with a new loan under a lower interest rate. After you refinance, you'll still owe the same amount of debt, but you’ll pay less in interest charges each month. While this lowers your monthly payment, you may pay more interest in the long run.
More to keep in mind
Refinancing always has pros and cons. Here are 4 simple steps for ensuring a smooth experience:
- Check your credit score. The first step is to have a clear understanding of your credit situation. This will help determine if refinancing is even an option for you. Ideally, your credit score is higher when you first took out the loan.
- Consult with different lenders. Take the time to thoroughly research your options. Find which loan best suits you, starting with what’s feasible given your credit score. You’ll save time and suffer fewer dings on your credit, with each loan’s inquiry.
- Apply and wait for approval. Make sure to enter the correct information on your application. This may sound obvious, but simple errors can slow significantly down the process.
- Pay off your old loan. Some creditors will pay off your old debt for you (if you provide them with details on the application). However, in some cases, you might receive a lump sum amount to pay off your old loan. Use that money for its intended purpose and pay off your old loan immediately.
How Bright can help improve your credit
A healthy credit score can often lead to a lower interest rate on a refinanced loan. It’s worth working on your credit before applying -- and Bright can help boost almost any credit report.
Bright can pay off your credit cards faster, making smart payments for you, always on time and optimized to save you money. With more on-time payments and a lower utilization rate, Bright can improve your credit score automatically.
Bright doesn’t provide debt consolidation loans, but we do offer two other solutions, Bright Credit Builder and Bright Balance Transfers. They’re smart alternatives, with competitive rates and built-in automation.
Bright Credit Builder is an easy and safe way to boost your credit score - with instant approval, no extra fees and no credit check required. Once you’re signed up, we’ll set up an interest-free, secured line of credit and use it to make automatic payments on your cards, building a positive payment history and lowering your credit utilization. Bright Credit Builder focuses on utilization and payment history because as they improve, your credit score goes up!
Bright Balance Transfer offers a low-interest line of credit designed to pay off card debt fast while saving you from high interest charges. Once approved, Bright uses the funds from your Bright Balance Transfer to pay off your high-interest cards, moving those debts to our balance transfer program with its lower APR. Over the months ahead, Bright automates your new repayments, too, so you pay less in interest and it’s hassle-free. Bright Balance Transfers offers credit lines of up to $10,000 at APRs starting from 9.95%, depending on your eligibility.
If you don’t have it yet, download the Bright app from the App Store or Google Play. Connect your checking account and your cards, set a few goals and let Bright get to work. Once you sign up, you can apply for Bright Credit Builder or Bright Balance Transfer or use MoneyScience™ to pay off your cards fast.