Does refinancing a loan affect your credit score?

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With Canadians carrying a near-record level of household debt, loan refinancing is becoming more common. But when should you refinance a loan - and how does it affect your credit?

Why refinance?
One of the main reasons to refinance a loan is to take advantage of better rates and loan terms, but there are other reasons, too.

For instance, if your current monthly obligations are too high, you might try refinancing your loan or loans over a longer period to lower you monthly payment, Laurie Campbell, CEO at Credit Canada Debt Solutions, said in an emailed response to questions.

You may also want to refinance a loan to add debt to it, she said. For instance, if you have a credit card balance with a high interest rate, you might be able to refinance a line of credit or personal loan to add the credit card debt to pay less interest.

"Refinancing a mortgage and adding in additional debt, such as credit card debt, is a good idea, as long as it is not a cyclical habit," said Campbell.

"People sometimes refinance a loan to get rid of high interest debt only to falsely believe they are in less debt since their high interest debt, usually credit cards, is now paid off," said Campbell.  "Then they go out and rack up the credit cards again and voila! They now have a ‘bloated' loan and a bunch of credit card debt, so they are worse off."

There are other dangers and factors to consider with refinancing, too.

"I am not a fan of stretching out any car payment or debt, unless it is at zero interest, as it is a depreciating asset," said Campbell. "Student loan debt could be consolidated into another debt vehicle, provided it is at a lower interest rate."

Refinancing and your credit score
Although refinancing a loan can help you in many ways, it likely will affect your credit score, at least a little.

Refinancing a loan triggers a hard inquiry when the lender pulls your credit file, David Blumberg, public relations director at TransUnion, said in an emailed response to questions.

If your score is good, one hard inquiry shouldn't do too much damage, and it should be a temporary dip. However, too many hard inquiries in a short period can make it appear to lenders as if you are desperate.

Additionally, if the loan refinance is considered to be a new loan (rather than changes to the terms of your existing loan), and the terms and balance of the loan change, it may be reported as a new loan on your credit report.

A new loan on your credit report can negatively impact your credit score, said Campbell.

How can you minimize the impact of a loan refinance on your credit score? Apply to refinance a loan only when you're sure it will make financial sense.

If a loan refinance makes sense for you - you have a plan to pay it off, you won't rack up more debt and your score is in fair-to-good standing - you likely don't need to worry about this one-time, short-term credit hit. The benefits of lower interest will likely far outweigh the credit score damage.

See related: Want -- or need -- a lower rate? Try asking, 5 factors in choosing a debt consolidation plan, 4 common debt consolidation mistakes
Published June 30, 2017

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