If you have many debts, you might consider refinancing your loan. This can reduce your interest rate, making your monthly loan payment easier to budget for. But keep in mind that refinancing can impact your credit score in plenty of ways. So, it's important to understand how so that you can make an educated refinancing decision. In this article, we'll discuss how refinancing a loan works and explore several ways it could impact your credit score.

How does refinancing a loan work?

Refinancing a loan involves getting a new loan with a better rate or terms to repay an existing loan. As a result, you can get a better rate or a different loan term. In some cases, refinancing may accompany loan consolidation. When you consolidate loans, you use one new loan to pay off several old loans. This streamlines your loans by giving you a single payment, often at a better overall interest rate.

4 ways refinancing a loan impacts your credit score

Here are some ways refinancing a loan can affect your credit score:

1. Can slightly lower your score when you apply

When you refinance, you take out a new loan. This triggers a formal credit check, called a hard inquiry, which can slightly lower your credit score. Luckily, the effect of this hard inquiry fades after a while. Plus, the hard inquiry falls off your credit report after two years.

2. Could lower your score by reducing your credit mix

Credit mix is one of the five credit score factors. It measures how diverse your types of accounts are. For instance, imagine you have a student loan, auto loan, and credit card. Refinancing the student loan and auto loan into one loan could reduce your credit mix, which may lower your score.

3. Makes credit-boosting on-time payments easier

Your payment history is the most important factor of your credit score. Refinancing loans can get you a lower rate and reduce the number of loans you have to juggle. This makes it easier to pay all your monthly debts on time. Consistent on-time payments can boost your score significantly over time.

4. Can boost your credit score by lowering credit utilization

Credit utilization is a credit score factor measuring your total credit card balances relative to your total credit card limits. The lower the ratio, the better the score. If you have a lot of credit card debt, you may have a high utilization ratio. Refinancing can help you pay that debt off, reducing your ratio and improving your score.

The bottom line

Loan refinancing doesn't just offer you a shot at more affordable monthly payments. It can also impact your score in several ways. The hard inquiry can ding your score slightly, and a reduced credit mix may also have a negative impact. But keep in mind that the effect of the hard inquiry will fades. Plus, you can reduce your utilization ratio, and the affordable monthly payment can allow you to make more payments on time, which can increase your score. Ultimately, you must make sure the refinancing loan makes your overall debt payments more affordable to fully reap the benefits.

Notice: Information provided in this article is for information purposes only. Consult your financial advisor about your financial circumstances.

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