Refinancing a mortgage is an extensive process with a lot of moving pieces. Not a lot of people truly understand how much your credit score can impact this process. Refinancing a mortgage will impact your credit score. This means before embarking on that journey you’ll want to make sure you understand how your credit score affects the process.
What Impacts Your Credit Score
Before you can understand how a mortgage refinance can impact your score, you will want to understand the factors that affect credit overall. There are numerous factors but four main ones are:
Payment History (35% of Your FICO Score)
This is the most impactful factor on your credit score. If you miss bills or even pay bills late then you will quickly see your score decrease. The reason that this plays such a role in your credit is because of the fact that lenders can look at this to see how you are as a borrower. If you are constantly making late payments, or miss payments then they will be more hesitant to lend you money.
Credit Usage (30% of Your FICO Score)
Your credit usage looks at a ratio to determine credit utilization, and not so much the overall amount of debt that you owe. You can determine this credit ratio by dividing your total revolving credit that you are using by the sum of all your lines of revolving credit limits. Lenders rely on this number to show them how much of your credit you are reliant on.
Credit History (15% of Your FICO Score)
The age of your credit impacts your score. Lenders look at not only the age of your oldest form of credit, but your newest one as well. A good rule of thumb is the longer the good credit history, the better the score.
Credit Mix (10% of Your FICO Score)
Lenders want to see that you can take on multiple forms of credit. There are three main types of credit:
- Revolving (Credit Cards)
- Installment (Loans)
- Open Accounts (Utilities and Some Bills)
The more diversity on your credit report then the better you are in the eyes of the lender. This shows that you can properly manage your credit no matter the type!
Do Open Accounts Impact Your Credit Score?
Think of open accounts like utility bills and phone bills. These do not automatically impact your credit score. If you want them considered, you’ll need to use specialized services, like Experian Boost, to have them reported. While you could see an immediate increase to your credit score, you will likely just see your score stay the same but have an improved credit history moving forward. The more reported lines of credit then the better diversity which can help your score (if responsibly managed!).
How Does Refinancing a Home Affect Your Credit Score?
You could affect your credit score in a number of ways when refinancing a mortgage.
How Can a Mortgage Refinance Lower Your Credit Score?
There are a couple different scenarios where you could lower your credit score with a mortgage refinance.
Your mortgage is a home loan. Your loan is provided by a lender. In order for the lender to determine your ability to repay the loan, they will need to look at your credit standing. This means obtaining your credit report. However, in order to obtain a credit report, a lender must have a signed authorization from the borrower. This results in a hard inquiry. Hard inquiries have an impact on your score and can temporarily cause your credit score to go down. Typically these hard inquiries can reduce your score by roughly 5 points at most. These hard inquiries will stay on your credit report for two years until they fall off. The newer they are, the more of an impact they have on your score.
However, just because it lowers your score does not mean you should avoid a refinance. Your credit score may take a temporary fall but over the course of the loan it could build back up to the original score and then some!
You Submit A Lot of Loan Applications
When you are looking to refinance your loan, it is encouraged to compare your lending options. If you are trying to get realistic estimates on your financing options, you may need to submit a hard inquiry. If you do this for multiple lenders, this results in multiple hard inquiries.
In order to avoid multiple hard inquiries, you need to be aware of your timeframe for the refinance. Make sure you submit your hard inquiries within a 14 day to 45 day period. Each credit scoring model is different and may have different guidelines on what their grace period is. If you submit your inquiries within this time frame, you may be able to have that count as one hard inquiry. It is best to err on the side of caution and keep it within 14 days. This reduces the impact that the hard inquiries could have on your credit score. If you don’t pay attention to the time frame and submit multiple hard inquiries over the course of a few months, then you will see the impact!
A Newly Closed Account
It may not make sense but bear with us. The original loan that you have will need to be repaid in order to get the new loan. This means that you will be closing an account that you’ve had for a long time. When you close an account that is on your credit report, it lowers your score. Depending on the credit scoring model, some may take the payment history of the closed account into consideration. Usually, the better the health of the account that closes then the less of an impact to your credit score.
A New Loan on the Account
When one door closes, another opens. In this case, when one loan closes, another takes its place. However, unlike the original loan that had active account activity and a history of repayment, this new loan is fresh. No history of repayments which means no positive impact to your score.
How Can a Mortgage Refinance Raise Your Credit Score?
There is the possibility that you could raise your score, not just lower it! If your current mortgage is too much to handle, then a mortgage refinance may be what you need to get a better handle on your finances. When you properly budget, you may be able to use the extra funds that you save monthly on handling other areas in your financial life that need work.
You can dedicate the funds towards tackling other debt like credit card debt, you can build up your emergency fund, and more! While the negative impact would still occur temporarily, it can be worth it in the long run.
Should You Avoid a Cash-Out Refinance?
Cash-out refinances have not one, but two impacts to your credit score. The first impact is like any other refinance where you replace the older loan with a lot of credit history to a new loan with no credit history. The second impact is the fact that your credit utilization ratio may be affected. Keep in mind that your credit utilization makes up 30% of your credit score!
A cash-out refinance provides you a larger loan amount in order for you to cash out on the equity of your home. However, this means that you will have a larger account balance that you are still required to repay. This doesn’t mean you should avoid a cash-out refinance all together, but it is something to be aware of.
There are some other tips that can help you better handle the mortgage refinance process.
The best way to handle a mortgage refinance is to be vigilant. Make sure you are aware of when your new loan payments will begin. It is important to continue your old payments in the meantime. Missed payments can have a serious impact on your credit score. Even if the lender says that the new loan will pay off your last payment on the original mortgage, make sure to pay it regardless.
It is important to compare your lending options in order to find a mortgage that works for your financial situation. When comparison shopping make sure to keep your applications within a 14 day time frame. This may seem short, but some credit scoring models only allow this timeframe to be the limit of what is considered “one hard inquiry” compared to seeing multiple on your credit report.
Avoid Defaulting on Your Loan
If your payments become too much to handle then you should talk to your lender. You may be surprised at how flexible they are when dealing with your situation. It is best to avoid defaulting on the loan because you can see a serious impact on your credit. Mortgage refinances may be a great way to improve the manageability of your monthly finances if your current mortgage is a lot to deal with.
You will for sure see an impact on your credit score when refinancing a mortgage. You will see your score lower but it may not matter in the long run. If you properly manage your credit then you can see your score raise back to the original score over time. You could even see your score increase!
There are ways that you can reduce the impact that you have on your credit score. Staying vigilant, properly comparing lenders, and responsibly handling your old mortgage are just some of the ways that you can better handle the refinance process.
At all costs avoid defaulting or foreclosing. It is important to handle your payments responsibly. If you find yourself struggling then speak to your lender. You may be in for a surprise at how flexible they could be when assisting you. You can also talk to a financial advisor that may be able to help you find a way to properly handle your finances.
If you feel you are being discriminated against, there are steps you can take. Mortgage lending discrimination is illegal. You can file a complaint with the Consumer Financial Protection Bureau or with HUD.
Commonly Asked Questions
How Long After Buying a House Does Your Credit Score Go Up?
You can expect to see your credit score get back to its original state in generally 5 months.
What if I Refinance More than Once?
While there is no limit to how often you can refinance, you want to be aware not to refinance too often. When you refinance you may increase the loan terms, submit many hard inquiries, increase the amount of interest you pay over the course of the loan, and more.