If you are looking to make your student loan debt more manageable then student loan refinancing is the right way to go. Refinancing does not always affect your credit score. You can optimize your debt repayment strategy and also save money by qualifying for a lower interest rate.
This will help you get lower monthly payments and also the payment needs to be made to just one lender instead of multiple lenders, which makes the process more feasible. This helps in tracking the payments to be made. If you restructure your debt well then you could even pay off your student loans ahead of time.
Refinancing sounds great but could this jeopardize your credit score? Let’s find out.
Table of contents
- How refinancing affects your credit score
- The Role played by credit during refinancing
- Protect credit during refinancing
How does refinancing affect your credit score?
Refinancing will not drastically affect your credit score. There are two types of credit checks one being a soft credit check and the other is a hard credit check. Let us look at them in detail and how they affect your credit score.
1 - Soft credit check - When you shop around for refinancing lenders, like banks, credit unions, or online lenders. They might conduct a soft credit check. This will not affect your credit score too much. These inquiries do not show up on the credit report and are done usually during the pre-approval process.
2 - Hard credit check - After you look around and decide on a lender. Then you move forward with an application, once this stage is reached a hard credit check is performed. This hard inquiry will affect your credit score but only by five points or fewer.
Now if you go ahead and submit several applications with different lenders, you could definitely see a drastic change in your credit score. This way you need to plan well when you go about applying for refinancing.
3 - Short credit history - If you have a short credit history and a lesser number of accounts with many hard pulls done on your credit during a short period of time. This can lead to a drastic effect on your credit score. If you have several inquiries on your credit report then it is a bad sign to your lender, as this shows a continuous interest on a line of credit from the borrower's end which can raise questions on the borrower's credibility.
4 - Multiple hard inquiries - But it should be noted that several hard pulls done for the same type of loan are counted as a single inquiry. Credit bureaus will take this as a sign that you were trying to get the best deal before obligating yourself to the loan.
5 - Addition of new credit - This is mostly overlooked during refinancing. When you add a new credit account to your profile your credit score is affected. According to FICO, the following factors are taken into consideration
Payment history (35%)
Amounts owed (30%)
Length of credit history (15%)
New credit (10%)
Credit mix (10%)
When you refinance you close an old account and open a new account with new credit. This process will affect your credit score.
6 - After you get your refinanced loan - Apart from applying for a loan. When you get approved and you get your loan. The way you go about paying back your loan will play a huge role in your credit score. It is always advised to make timely payments, this could help boost your credit score.
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Does credit history play an important role while refinancing?
If you are planning to take up refinancing in the future and not immediately, then the impact of refinancing on your credit should not be of much concern to you. Unless you are in talks about making another large financial decision like buying a car or house.
Even applying for a credit card can be a huge financial decision as it sets up a new line of credit which can affect your credit score.
Taking several large financial decisions in a short period of time will lead to several hard pulls and can categorize you as a financial risk in the eyes of a lender. In case you do get an inquiry on your credit give it about two years and then take another large financial decision. These two years will help the inquiry settle down on your credit report.
When should you avoid refinancing?
Although refinancing has its own advantages and many people may prefer to refinance. You cannot decide, without knowing the limitations to it. Therefore, refinancing might not always be the best option for you. Below is the list of factors you must keep a note to know why refinancing is not always good.
1 - If you refinance federal to private student loans you will not be eligible for federal income-driven repayment plans, deferment, federal forgiveness programs, forbearance, etc.
2 - As commonly known, federal student loans come along with protection benefits, and it is not worth refinancing your federal loans as you will lose these benefits even if you refinance for lower interest rates.
3 - Before refinancing if you don't choose a different repayment plan you will not be able to save money. So make a proper comparison before you refinance with your new lender.
4 - If you do not qualify for a lesser interest rate, you lose the purpose to refinance as there is no benefit attached to it.
Refinancing is favorable only when you find a lender who refinances your loans with a lower interest rate.
The federal government introduces multiple protection acts during a national emergency, natural disaster, etc. Private student loans do not get to avail of these benefits.
Worried about your tuition? Learn more about best student loans
Ways to protect your creditworthiness during refinancing
To help prevent your credit score from being affected by refinancing you need to try and apply only with the lender you are comfortable with. Whose terms and conditions are best suited for your financial conditions. Minimize the number of applications with different lenders as this will result in several hard pulls which will affect your credit score.
Here are ways you can protect your credit from refinancing
1) Stay on top of your refinanced student loan
Try and keep on-time payments on your newly refinanced loan and do your best to not skip any payments. When you miss a payment it will without a doubt affect your credit score. These late payment reports stay on a borrower's credit report for up to 7 years and are reported in as little as 30 days.
It is for this reason that you need to try and choose repayment terms that work well with your budget. Although the short term looks tempting and can help you get out of debt faster you will have to make large payments each month.
Private lenders do not have a penalty with extra payments, so you can use this for your advantage. Take up a longer repayment term and make extra payments towards the principal amount of your loan so that you can get out of your debt faster.
If you have taken up a term and you find it difficult to make a payment then you should speak to your lender about it. Don’t wait until you have to make a payment to make contact with your lender. Talk about the hardship in making the payment and see if any alternatives are available.
Try and reach out to all options provided to not fall into default. It should be noted that it is difficult to discharge student loans during bankruptcy and once defaulted it can have a long-term consequence on your credit score. Instead, choose to make on-time payments and build your credit score.
2) Keep making repayments until refinancing is approved
It should be noted that the process for refinancing takes time and one should not defer making payments on their student loans. There are changes if you forget to make your payments towards your loans, your loan can move into default, which can severely harm your credit score.
And if you stop prematurely in making your payments then your lender could report your payments as late or miss to the credit bureaus which will hurt your credit score. To prevent this from happening you should not stop any payment until you are completely sure that your refinancing process is completed. You can contact the private lender to ensure if the refinancing process is completed until which you continue your repayment process.
3) Pick a lender with the best offer
As mentioned earlier only when you apply will a hard credit check be conducted, this will affect your credit score by five points or fewer. Refinancing is an important decision, it is advised to check out at least three offers before you go ahead and pick a lender to settle.
You can check the rates you get through pre-qualification, doing this won't affect your credit score. Use this to compare your options and check the lowest rate you can qualify for.
Refinancing is a big decision one has to make but it should not be done with your credit score on the line. Always be aware of all the options you have and pick the one which is best suited for your financial condition.