Would you like to lower the amount you pay each month to service your debt? This includes every type of debt you have, including any student loans you have. If you can refinance to a lower interest rate, you can free up some money that you can use to put into a savings account, pay off your debt more quickly, invest, or buy things you want that you currently can’t afford. Before you apply to refinance your student loans and other debts, you may want to consider how it could affect your credit score.

What is refinancing?

If you get a new loan to pay off an old one, that process is called refinancing. The reason that borrowers may do this is that it can lower their monthly payments. This is because:

  • Interest rates have gone down since they took out the original loan
  • The borrower’s credit rating has improved so that they will pay a lower interest rate
  • They can consolidate several loans to create a single payment that may save them money

Why would refinancing a loan lower your credit score?

In the case of refinancing a loan, lenders evaluate whether or not you are a good risk by running a credit check. This will look at factors such as your total debt load and your payment history.

There are two types of inquiries. In the case of a soft inquiry, a monitoring service does a credit check and will not hurt your credit score. However, most lending institutions do a hard credit check. This could decrease your credit score by as much as 5 points.

Note that when you refinance an existing loan, it closes out that account. This can also lower your credit score. This is because FICO (Fair Isaac Corporation) creates an average based on how long you’ve held your accounts. The longer you’ve held an account, the more it will affect your credit score. However, if you have made all of your payments on time, then the negative effects of closing that account will be minimized.

What is FICO?

Lenders use a borrower’s FICO score as one way to assess that borrower’s credit risk. FICO scores look at five areas – payment history, current debt level, the types of credit the borrower has used, the length of his or her credit history, and new credit accounts.

Should you refinance your loan?

There are certain times it makes sense to refinance a loan. For student loans, when you took out the loan, you probably had a limited credit history. Hopefully, as you’ve been working, paying bills, including debt payments, your credit score has improved, and your credit history provides lenders with a track record that shows you are a good credit risk. Another reason to refinance is that interest rates have fallen since you originally took out the loan. According to Lantern by SoFi, “The actual terms you may receive depends on the things like benefits requested, your credit score, usage, history and other factors.”

For most people, as long as you continue to make payments on time in a few months, your credit rating should be back to normal, so there won’t be any long-term effects. Therefore, it often makes sense to refinance student loans. For those seeking the most competitive rates, Lantern by SoFi is a great site as it will allow you to easily find the best options.