What is Refinancing?

Refinancing is the process of replacing a current loan with a new loan. Loan interest rates, term lengths, and other loan features are constantly changing. Refinancing is appealing to many people because it allows them to adjust their current loan terms. Often, refinancing to a lower interest rate loan can end up saving one thousand dollars a year on their loan. With potential savings like this, it's wise to investigate refinancing your mortgage loan periodically.

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A common concern many consumers have with refinancing is the potential impact it may cause on their credit scores. A credit score is a core element of a consumer's overall financial health. Good stewardship of a credit score opens consumers up for favorable terms in many loan categories. Whether it's a potential mortgage loan, student loan, car loan, or personal loan, getting favorable rates and loan terms is critical. Often these terms are directly related to an individual's credit score. So being mindful of how refinancing will impact such a critical financial metric is wise.

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How Refinancing Can Lower Your Credit Score

Refinancing may potentially lower your credit score. Often, depending on the number of lender inquiries, the amount it lowers your credit score is minimal. However, the impact refinancing will have on your credit is worth understanding. It's helpful to understand this potential negative impact up-front instead of down-the-line through a surprising reading of your credit report.

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Below are several ways refinancing may affect your credit score:

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Credit Inquiry

A credit inquiry is a request made by a lender to view a consumer's credit report. A credit report includes detailed information about an individual's credit history and other information. This information consists of any monthly payments made or missed on previous debt obligations or loans. It also contains a list of current and previous lines of credit, loans, and their respective payment histories.

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Within credit inquiries, there are two types: soft inquiries and hard inquires. A soft credit inquiry is a light request made by lenders, other third parties, or even a consumer accessing their own credit report. Soft inquiries can be thought of as informal requests to see an individual's credit history. These types of inquiries don't decrease a credit score, although they are disclosed as a separate inquiry category on the credit report.

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Hard credit inquiries are much different. A hard inquiry is a formal request to view an individual's credit. These hard inquiries occur when a consumer is formally applying for a new mortgage loan . Hard credit inquiries may cause a slight ding in your credit score, depending on the number of inquiries and the timing of those inquiries. The negative impact of hard inquiries can compound if there are multiple inquiries in a short time. 

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Multiple hard inquiries may lower an individual's credit score because credit bureaus see it as an indicator that someone is potentially becoming financially overextended. Even if this is not the case, a hard inquiry counter is part of the algorithm determining an individual's credit score.

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Average Age of Your Credit History

Your credit score is an amalgamation of factors, each receiving a different weight of significance. One factor that weighs heavily on your credit score is your average age of credit. This factor is simply the average amount of time all your credit accounts have been open. The longer your average age of credit, the more this factor benefits your credit score.

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When it comes to refinancing, a consumer is potentially closing a longstanding loan to open a new loan. Opening up a new loan in this way closes one's previous loan. Whether this refinancing occurs on a mortgage loan, an auto loan, a student loan, or a personal loan, the effect is still the same: a loan closes to open up a new loan.

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When you open a new loan like this, your average age of credit potentially shrinks - the longer you’ve been making monthly payments on the old loan, the greater your credit score may dip by opening this new loan if you have no other credit with longer terms.

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Lower Credit Utilization

Another factor that is strongly considered when determining your credit score is your credit utilization. This factor is calculated by dividing your used credit by your total available credit/credit lines. Credit utilization is often expressed as a ratio or rate. The lower this rate, the higher this factor of your credit score will be.

Understanding the ways refinancing can lower your credit score will help save you from unnecessary frustration and surprise. Furthermore, understanding these factors ahead of time will help you mitigate their adverse effects on your credit score.

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When Should You Refinance a Loan

Timing is essential when refinancing. However, your best time to refinance is dependent on your unique financial situation. The best time to refinance is when you stand to save the most money. Finding this right timing can be tricky.

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Calculating potential savings on a mortgage loan depends on considering the length of the loan, the interest rate, and the monthly payment requirements. Furthermore, mortgage loans can have additional expenses like private mortgage insurance (PMI). Often refinancing a mortgage can get a borrower out of their PMI requirements. Eliminating this monthly premium stands to save you considerable amounts of money.

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Each loan type has nuances to its terms. It's essential to understand your full loan terms. Understanding these terms helps you effectively weigh cost-saving opportunities when refinancing.

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Ways to Protect Your Credit When Refinancing

Refinancing may save you considerable money on your current mortgage loan terms. However, refinancing can also lower your credit score by potentially shortening your average account lengths,  and placing multiple hard inquiries on your credit. These items are important to keep in mind, but there are ways to mitigate their effect.

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Understand your Credit Score

Before refinancing, you’ve got to understand your current credit score. It's helpful to request a copy of your credit report if the details of your current credit are foggy. Credit reports help you assess your current creditworthiness and give you a good idea of your refinancing options. If a lender gives you better terms on your current mortgage loan, they want to see you’ve exercised responsible credit stewardship.

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Responsible credit stewardship is reflected in an individual's credit history. An area of your credit history that weighs heavily towards calculating your credit score is your payment history. Having low to no missed payments on your payment history is an excellent indicator of creditworthiness. Responsible stewardship of past student loans, personal loans, and mortgages all help increase your odds of favorable refinancing.

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Wait for the Best Time to Refinance

Refinancing is often a waiting game. Most people take decades to pay off major loan types like mortgages. Since these loan types are long-term loans, consumers have a decent amount of time to find the right moment to refinance.

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Your credit score is one of the most prominent factors influencing which refinancing opportunities you qualify for. Lenders need proof that a potential borrower is trustworthy with past debt obligations. The way lenders evaluate this is through an individual's credit score. Credit scores are confusing at times. However, understanding which factors contribute to lowering or raising your score helps clear the fog. Take a moment to read this article if you want more information on how credit scores are calculated.

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One of the best times to refinance is when your credit score is in great condition. If you want to refinance your current mortgage loan, start working on your credit score. It's easy to hurt your credit if you're not intentional about your credit management. If you haven't already, request a credit report from a reputable source, such as https://www.annualcreditreport.com.

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Credit reports help you see where your credit currently sits. This information can help you decide where you want your credit to be. Getting your credit score into a solid range before refinancing will help you secure the best loan terms. So, it’s helpful to wait until your credit is in a good range before attempting to refinance.

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Group Refinancing Applications

Every time you apply for a new mortgage loan with a new lender, a hard inquiry is run against your credit. Too many hard inquiries over time may potentially lower your credit score. Thankfully, if you are applying for a mortgage loan, a group of hard inquiries over a several-week time window, will have a lesser impact on your credit score. 

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This information is essential when refinancing. As soon as you fill out your first formal application with a lender, try to submit all other refinancing applications within a short period of time if you are shopping lenders. 

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Don't Open New Accounts

Every time you apply for a new mortgage loan, credit card, auto loan, or personal loan, a hard inquiry is run against your credit. If you try to apply for a credit card around the time you plan to refinance, this could hurt your credit score and potentially may impact your mortgage loan application. So try to plan your refinance at a time when you haven't applied for any other lines of credit recently and do not apply for any new loans or credit cards while your mortgage application is pending.

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How to Prepare for Refinancing Your Home

• Before making any significant financial decision, it's always best to check your credit. Having a good credit score will open up many refinancing options that you wouldn't have otherwise. So check your credit! Request a copy of your credit report if you haven't already.
• Next, it's time to fill out an application! Remember, whenever you officially apply, the process will create a hard inquiry on your credit. Be prepared for this by following the steps mentioned earlier in this article.
• Lastly, it's essential to continue paying your current mortgage loan until its payment cycle ends. Consumers may make the mistake of getting approved for refinancing and miss some payments on their old loan during the transition. Remember, you are still under the obligation to make timely payments on your existing mortgage loan until its payment cycle ends.

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What To Do After Refinancing

Once you've completed the refinancing process, you'll want to steward your new loan terms wisely. As with any loan, make sure to make timely monthly payments. If you want to aggressively pay down your loan, you can try making two payments a month or pay additional money toward reducing the principal each month. If you try this strategy, just make sure your first payment is always meeting your monthly payment amount and is paid by the monthly due date.

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However, be aware that your credit score may temporarily drop after you've successfully refinanced your loan. This drop is partially due to the hard inquiry run against your credit, but it's also an effect of taking on a new loan with limited payment history. This dynamic is why making timely monthly payments are so important. After taking on a new loan, lenders want to see how you're handling your new mortgage loan. Making timely payments proves to them you're able to manage your new loan terms.

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To learn more, contact Wesley Mortgage today!