Can refinancing affect your credit score?

Home loan repayments generally take the largest slice of a mortgaged homeowner's day-to-day budget. No wonder, then, that savvy Aussies strive to find the best deal they can qualify for.

If you've found yourself with a subpar home loan product, refinancing could reduce your regular repayments, provide you with greater flexibility, and even allow you to pay your mortgage off faster.

However, there are a few downsides to refinancing. One being that it can negatively impact your credit score.

See also: How to check your credit score

How can refinancing affect your credit score?

When you refinance a home loan, you essentially agree to open a new mortgage and use funds from it to pay down your old mortgage. That's the case even if you're applying to refinance with the same lender.

What is a credit score?

Charlotte Rankin, director of client advisory at credit reporting bureau Experian, advises it's important to understand how your credit score is calculated so you can make an informed decision on whether or not to refinance a home loan.

"A credit score is dynamic and can change with certain types of behaviour," she told Your Mortgage, noting each credit reporting bureau uses a slightly different algorithm and specifics aren't disclosed in detail.

Key factors that can influence your credit score include:

• How meticulous you are at meeting regular home loan or consumer credit repayments

• The credit limit of your credit products

• The kind of credit products you've applied for (e.g. credit cards, personal loans, or home loans)

• How many applications you put in for credit products

• Negative events such as defaults, judgments, or bankruptcies

"Not all contributing factors are equally weighted in determining a credit score, and they do not necessarily affect all people in the same way," Ms Rankin said.

So, with that in mind, here are some of the main ways refinancing could impact your credit score:

Refinancing impact on credit score #1: Credit enquiry

The lender providing your new home loan will conduct all the checks and balances you might expect - including casting its eye over your credit score. It will request what is called a 'hard' inquiry or credit check, which can leave a mark on your credit report.

Hard credit inquiry

A request by a lender or financial institution to review an individual's credit report as part of the decision-making process for a loan or credit application.

A hard credit inquiry, also known as a 'hard pull', can lower your credit score and will typically remain on your credit report for up to five years, but that alone shouldn't stop you from refinancing.

Chances are, most lenders won't be too put off if an applicant has a couple of hard credit checks on their record, especially if those checks are spaced out over a few years.

Ms Rankin warns borrowers against 'shopping around' for credit products like home loans, however, as multiple hard inquiries can dent your credit score over a longer period.

Refinancing impact on credit score #2: Missed repayments

Another way that refinancing can negatively impact your credit score - albeit indirectly - is if, amongst all the kerfuffle of refinancing, you miss a repayment or two on either your new home loan or your old one.

"If you're refinancing a mortgage, make sure that you continue making payments on your old loan until it is closed," Ms Rankin said.

"Once your new mortgage loan is approved, it's easy to get confused as to what payments are due, when and to which lender.

"It remains your responsibility to ensure that the final payment is made on time on the old loan."

Myth or fact: Closing a home loan facility can negatively affect your credit score?

You might've come across warnings that closing a credit account could harm your credit rating. Fortunately, that's unlikely to be the case in Australia.

"Closing a credit account, whether it be a home loan, credit card or personal loan, is unlikely to impact a credit score significantly," Ms Rankin said.

"In the same vein as applying for a new mortgage, the closed account may give a credit score a boost, depending on other financial factors.

"A newly refinanced account can also result in some lost credit score points due to a short open account history, but this is usually not enough to be detrimental to an overall credit score."

Even if refinancing does negatively impact your credit score, its impact is likely to be short lived, especially if you continue to meet your mortgage repayments going forward.

Is refinancing a good idea despite potential damage to your credit score?

While a hard credit inquiry will stay on your credit report after refinancing, which might slightly lower your credit score, the real-world impact is usually minimal.

In fact, the potential benefits of refinancing - such as securing a lower interest rate or better loan terms - often far outweigh the minor dent in your credit score.

Some of the potential benefits of refinancing your home loan include:

• Realising a lower interest rate
  Refinancing could help you secure a more competitive interest rate, reducing your monthly repayments and saving you money in the long term.

• Securing a shorter loan term
  You might choose to refinance to a shorter loan term, allowing you to pay off your mortgage faster and save on interest.

• Gaining access to improved loan features
  Refinancing can provide access to better loan features, such as an offset account, redraw facility, or the ability to make extra repayments without penalties.

• Allowing you to consolidate other debts
  You may be able to consolidate other debts, like credit card balances or personal loans, into your home loan, simplifying your repayments and potentially reducing interest costs.

My credit score is low. Can I still refinance my home loan?

Having a low credit score doesn't necessarily disqualify you from refinancing your home loan. Though, it might make things trickier. Lenders may offer you less favourable terms, such as a higher interest rate, or require additional documentation to assess your financial situation. You may also have fewer lender options to choose from, as some may have stricter credit score requirements.

If you're unsure how your credit score stacks up, compare it to this tier system offered by Experian:

800 - 1,000	An excellent credit score
700 - 799	A very good credit score
625 - 699	A nice and average credit score
550 - 624	An okay credit score
0 - 549	Below average and may be considered a poor credit score

That said, if you have a stable income, significant equity in your home, or a strong repayment history, you might find refinancing relatively simple despite a less-than-ideal credit score.

"It is important to note that when applying for a new credit product, it is not just the credit score that is taken into account," Ms Rankin said.

"Most lenders will also look at your ability to service the loan on an ongoing basis and any other data they have available."

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