How Student Loan Refinancing May Affect your Credit Score

From nearly the first day you graduate college, your inbox naturally begins to overflow with offers to assist in refinancing your student loans. Sometimes, refinancing is a great idea. You can potentially save thousands by refinancing a loan with a lower rate. However, there are more items to consider than just interest rates and monthly payments. Refinancing can affect your credit score in both minor and significant ways. By thoroughly knowing what to expect, you can make the right decisions for your wallet and maintaining good credit. Learn what to expect at every step of the way.

Shopping for a New Loan

The first step in refinancing is shopping for loans and comparing your options. What’s available to you will depend on factors, such as current credit health. The assessment typically begins with a credit check, also known as a soft pull. A soft pull allows potential creditors to view your credit report and score so they can assess your credit risk. Soft pulls are utilized for what is known as pre-qualifying you. Pre-qualification gives a lender general information so they can decide whether to extend an offer. It does not guarantee that you will be offered a loan. This sort of pull does not affect your credit score. However, be aware that some sites will do a hard pull, which is associated with an attempt to gain new credit and affects your score. Hard pulls give lenders similar information; a key difference is that they are reported while soft pulls are not. Because it’s an attempt to gain new credit, lenders can foresee multiple inquiries as a sign that they are not using credit responsibly. Having a few clustered together shows that one is shopping and will not have a negative effect.

Applying for a Loan

When you’ve chosen a loan and applied, someone will perform a hard credit pull. The effect on your credit score is not extreme. New credit, which includes hard inquiries, accounts for 10% of your FICO score. It’s expected that people will periodically add new credit products, allowing additional inquiries not to impact your score. Many random pulls over a long period have the power to harm you potentially. What may potentially harm you Too much interest in new credit can signal to lenders that you are overextended. 

What Factors Make It Harder to Refinance?

Your overall credit score is typically the biggest decider in what sort of interest rates and loan terms lenders can offer. Your credit score is made up of five major factors. Payment history, the recorded history of paying on time, will have the most significant effect, seeing as it makes up 35% of your credit score. Paying on time every month can keep this sector healthy. 

Other factors that may have an effect are things like credit utilization, the length of your history, and your credit mix. Credit utilization refers to how much available credit you are using. If you own maxed-out credit cards, your utilization rate may hurt your score. 

A factor you don’t have much control over is credit age, allowing it to become a lower factor, making up just 15% of your score. The longer you use credit, the higher this segment will be.

Your credit mix is another factor that affects your score. Lenders desire to see a mix of revolving credit, such as credit cards and installments, such as student loans. One should not receive new credit only to increase this area, seeing it only accounts for 10% of your score.

One Reason Your Score Could Fall

When you finish refinancing, your old loan will be closed, and the new one will begin. This action may cause a dip in your credit score. While it is surprising to some, there is a reason for a dip in the two-fold. First, cutting a loan short can reduce the average age of your accounts. Having a lower average credit age can harm your score because the longer you’ve used credit responsibly, the more confident a lender is in trusting you to pay in full and on time. Second, a closed tradeline can have an effect on your loan payment history. Since creditors calculate your score based on the history of making loan payments on time, changing that may negatively affect your appearance on paper. When it comes to your credit report, it’s all about the track record that lenders view. The lesser information lenders have to go off of, they are taking a higher risk (from their perspective). 

Keeping Your Score Healthy After Refinancing

The good news is that any adverse effects from refinancing will be eliminated when good financial habits are put in place. Pay your full loan payment on time each month. Apply for new credit cautiously, and become aware of the credit you utilize. Hard inquiries typically drop off your credit report within a year or two. Your average credit age and your long record of on-time payments will only grow.  

Refinancing can cause a small, temporary dip in your credit score; this is true. But, by keeping up good habits, you will probably find that choosing to refinance is a net benefit in the end. By having a better rate on your loan, you could save thousands of dollars on interest over time. As a result, you can place more funds in savings, possibly pay off your loan faster, and have more money available to put toward your most important goals.