If you’ve been paying on your student loans for a while, you’ve probably wondered whether you should refinance.
You’ve likely heard the pros: It’s a great way to consolidate and manage your student loan debt. And you might get a lower interest rate and pay off the loan faster.
But does refinancing hurt your credit? Let’s take a look at some ways it could — and the steps you can take to minimize the impact.
Credit inquiries
Lenders will run a credit inquiry to determine whether they will refinance your student loan. Multiple inquiries during refinancing can possibly affect your credit score.
To mitigate the damage, make sure to shop around to assess a variety of lenders first. Comparing rates requires only a soft pull on your credit, which doesn’t affect it much.
Once you’ve compared rates, choose the best offer, and then complete an application only to that lender. A full application will require a hard pull of your credit report.
Does a hard credit inquiry lower your score? Yes, but usually only by a couple of points. Hard inquiries typically stay on your credit report for two years before being removed. So be sure to limit lender applications during that two-year period.
Pro tip! Why does a hard credit check lower your score? The general thinking is that consumers with recently opened credit accounts are more likely to be late in making payments than those who have not recently opened an account, resulting in the slight dip in your score.
Keep making payments
Until your refinancing application is approved and your current student loan is paid off, you’re still responsible for making your minimum payment. Missing a payment during the refinancing process can significantly lower your credit score.
You generally have a grace period after the due date in order to make your late payment, but after that grace period ends, the lender will report the delinquency to the credit-reporting bureaus.
If your student loans are federal, and you are wanting a lower monthly payment, refinancing might be a bad idea: You may be better off keeping your current loans and exploring other options.
Changes to the loan terms
When you refinance, your loan starts over with a new term and interest rate. The interest and terms you qualify for will determine how long you will pay on the loan. The longer the debt is alive, the longer it stays on your credit report.
The bigger problem, though, comes from choosing a term that is too short, making your monthly payment higher than you can afford. If you’re unable to make the payments, you’ll likely have to go through the refinancing process all over again. Choosing a longer term, of course, means you’ll pay a lot more in interest.
Naturally, the best situation is a short-term loan with a low interest rate. Crunch the numbers, and determine if refinancing is worth it before going through with the application process.
Pro tip! You’re entitled to obtain a free copy of your credit report annually. You can also take a look at FICO’s formula for computing your score.
The bottom line
While refinancing a student loan can temporarily hurt your credit score, it should have a minimal impact. In fact, refinancing student loans can be a smart decision and could improve your credit in the long run.
If you decide to refinance, keep an eye on your credit, make sure your payments are posting as they should, and promptly dispute any errors.
