Many student loan borrowers will find that refinancing is a huge help to their credit score; others will see a refinance hurt their score.
Whether refinancing is good or bad for your credit score isn’t random chance or luck. Instead, it is a predictable change. This article will focus on the different factors that can move scores up and down.
Finally, for refinancing to be a net positive, borrowers need to avoid the one big mistake that can damage credit scores.
Credit Age: One way a student loan refinance can hurt credit scores.
Length of credit history is a significant factor in credit scores.
According to credit bureau Experian, credit history length is the third most important factor in a credit score. Experian claims that credit age makes up 15% of your total score.
A refinance can hurt your credit history length if the oldest item on your credit report is a student loan. Because refinancing pays off old student loans and replaces them with a new loan, borrowers erase old items from their credit reports.
If a borrower has student loans that are ten years old, but no other lines of credit, a refinance could hurt their score considerably. People who have credit cards or other debts that are approximately the same age as their student loans will not be impacted.
Sherpa Tip: Focus on the big picture. If you are about to buy a house and your oldest credit report items are student loans, refinancing could be a mistake.
However, keep in mind that the loan will eventually be paid in full and fall off your report. Borrowers must decide if they are willing to spend extra on student loan interest for the short-term preservation of their credit score.
The Big Help: Debt-to-income ratio changes
The debt-to-income ratio or DTI is a huge factor in any credit decision.
If you have ever been declined for credit due to insufficient income relative to your debt, it was a DTI issue.
Refinancing can replace many student loan payments with a single student loan payment. If that single student loan payment is smaller than the total student loan payments that it replaces, your DTI will improve.
A change in debt-to-income ratio can mean the difference between an approval and a denial on future credit applications. A better DTI will also allow borrowers to qualify for a larger mortgage when they buy a home.
The Little Harm: The Credit Inquiry
An unavoidable part of the student loan refinance process is the credit check.
Lenders require a hard inquiry which can negatively affect your credit score.
Most consumers will lose less than five points on average from a credit check. However, the exact amount of the drop can vary from one person to the next.
The good news is that the harm to your credit score is short-lived. As the inquiry ages, it has a reduced influence on the score. After a year, it doesn’t impact FICO scores at all. After two years, it isn’t even reported.
The Mistake to Avoid: Too Many Credit Checks
Most consumers know that shopping around to find the best deal is smart.
The importance of shopping around is especially true when it comes to student loan refinancing. The rates advertised by lenders and the rates actually offered by lenders can be very different. Additionally, each lender uses its own unique formula for deciding the refinance applications to approve and the rates to offer.
As a result, shopping around is essential for borrowers looking for the lowest possible refinance rate.
The good news for borrowers is that the credit bureaus will usually count multiple credit checks as one single inquiry. As long as the shopping around takes place within a 45-day window, it will count as a single inquiry on a credit report. However, some older versions of the FICO formula use a more limited 14-day window, so it is best to do all of your rate shopping in two weeks or less.
Spreading out refinance shopping over several months is an easily avoidable mistake. Put together a list of student loan refinance lenders, and complete all of your applications quickly. Each application takes about 10 minutes. Most borrowers can find the best rate on the market in less than an hour work.
Is Student Loan Refinancing Worth the Credit Risk?
Refinancing will cause some credit scores to go up and others to go down. For those that go down, the impact usually is minimal and short-term.
However, all borrowers should know that refinancing does put your credit score at risk.
For most borrowers, the decision comes down to opportunities. A good credit score by itself is worthless. However, having a good credit score can open many doors.
If you are buying a house soon, it might not be worth the risk to your credit score.
In most other cases, it is probably worth the small gamble. For many borrowers, their student loan debt is their largest debt and biggest financial headache. Refinancing can save thousands of dollars over the life of the loan.
The larger your loan balance and the higher your interest rate, the more worthwhile it will be to refinance.
Next Steps:
- Check Your Credit Score – All Americans can check their credit scores yearly on annualcreditreport.com. This credit check is free of charge and does not impact your credit score.
- Have a Plan to Refinance – A bit of research ahead of time can make it easy to stay under the 14-day shopping window. This site keeps a list of national refinance lenders and also tracks the lenders advertising the lowest refinance rates.
