- Refinancing student loans can have a positive impact on your credit score, but it can also hurt your credit.
- Understanding how refinancing can hurt your credit is key to taking steps to minimize the negative impact.
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Refinancing is a common solution for managing student loan debt. It allows you to exchange your existing student loans for a new loan with a new interest rate and different terms and conditions. Securing better terms on your student loans through refinancing can make the monthly payments more affordable. More affordable payments can help make easier to make on time payments, which in turn can help boost your credit score. However, there are some ways that refinancing can also hurt your credit.
Understanding how refinancing student loans can impact your credit – both positively and negatively- can help you take steps to minimize the negative impact of refinancing on your credit score.
How Refinancing Student Loans Can HELP Your Credit
When you refinance your student loans, you can choose to increase or lower your monthly repayment amounts to suit your financial circumstances. If you can’t afford the payments and are at risk of defaulting, you can lower the amount to make it more affordable.
Here’s how this helps boost your credit. Payment history has a big impact on your credit score. Regular on-time payments made in full can add up to 35% of your total credit score. On the other hand, even one late payment can damage your score. By lowering your monthly payments and making them more affordable, you’re less likely to miss payments. The regular on-time payments help steadily add points to your credit score.
If you qualify for a lower interest rate when you refinance, you can apply any extra cash you have toward your principal balance. Here’s how this will help your credit score. Reducing the principal balance reduces the total amount you owe, which can impact up to 30% of your credit score calculation. The less you owe, the faster you’ll be able to build your credit score.
How Student Loan Refinancing Can HURT Your Credit Score
Refinancing essentially means you are applying for a new loan. When you apply for student loan refinance, lenders approve your application based on your financial credentials. Your credit score also impacts your interest rate.
At first, when you’re just inquiring about interest rates, lenders run a soft credit check to give you a pre-qualified refinancing rate. This is only an approximate rate based on overview of your credit score. A soft credit pull does not impact your credit score.
If you decide to go ahead with your student loan refinance and submit a formal application, the lender conducts a hard credit check. This involves requesting the credit bureaus for a copy of your credit report so the lender can review it more thoroughly. This hard credit check will drop your score by a few points. This is a temporary drop.
But, if you submit multiple refinance applications to compare the finalized interest rates, every lender that receives your application and conducts a hard inquiry check. The multiple hard credit checks can reduce your credit score and damage your credit score more significantly than a single pull.
4 Tips For Minimizing The Impact Of Refinancing On Your Credit Score
- Use prequalification tools to get an estimated rate quote: Student loan refinancing lenders make it easy for prospective borrowers to get estimated rate quotes with no hard credit check. All you need to do is enter a few details into the online tool featured on the lender’s website. The tool gives you a personalized rate quote based on the details submitted. You can search for estimated interest rates on multiple lender’s websites without triggered a hard credit check and shortlist lenders offering you the lowest rate.
- Submit all loan applications within a 14 – 45 day window: If you decide to apply to multiple lenders to compare their final offers, it’s best to submit all applications with a 14 to 45 day window. When multiple hard credit checks are triggered within this short timeframe, some credit scoring models count them as only one inquiry. This will minimize the damage to your credit score.
- Keep making your monthly payments until the refinancing process is complete: It can take some time to complete the refinancing process after the lender receives your application. During this time, you must continue making payments to your original lender or loan servicer. Don’t ignore due payments until such time that the refinance process is complete, and you receive the new loan agreement. Stopping your loan payments prematurely will be considered as missed payments, which will impact your credit negatively.
- Stay on top of your student loan refinance payments: You’ve refinanced your loans to make them more manageable and build your credit score. Now take steps to ensure that all future loan payments go out on time every time. Remember, consistent, timely payments will boost your credit score steadily while even one missed payment can damage your score.
Important Note About Refinancing Federal Student Loans
Overall, refinancing student loans is a strategic move for making payments more manageable and saving money on interest. However, it may not be the best solution for managing federal student loans.
Federal student loans come with several benefits and protections including income-driven repayment plans, loan repayment assistance programs, and student loan forgiveness. When you refinance these loans, you’ll lose access to all these benefits. It’s best to only consider refinancing federal student loans if you’re certain you don’t need these benefits.
If you’re not ready yet to give up access to your federal student loan benefits, here are a few alternatives you can consider:
Enroll in an income-driven repayment plan: There are multiple income-driven repayment (IDR) plans that you can choose from. These plans lower your monthly payments to from 10% to 20% of your discretionary income. This makes the repayments more affordable, lowering the odds of missed payments that damage your credit. The plans also extend your repayment term to 20 or 25 years, after which the outstanding balance is forgiven.
Consolidate your federal student loans: Consolidation involves combining multiple federal student loans into one loan with a single payment due date. The interest rate on the consolidated loan is the weighted average interest rate of the original loans. While consolidation doesn’t lower your interest rate, keeping track of only one due date helps make payments more manageable and reduces the risk of delays.
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