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Refinancing your mortgage loan allows you to pay off your current mortgage and replace it with a new one. Typically, a homeowner refinancing a mortgage wants to improve their financial situation by locking in a lower interest rate, lowering their monthly payment, changing the repayment term, or cashing out some of their equity. However, even though refinancing often helps a homeowner’s bottom line, it can potentially hurt your credit score — at least temporarily.
If you’re thinking about refinancing your existing mortgage, you should be prepared for how the process will affect your credit.
In this article:
Learn more: Is now a good time to refinance your mortgage?
Refinancing your mortgage can negatively affect your credit score in several ways. These potential hits to your credit do not have to cause long-lasting damage as long as you know how they work. Here are the most common ways a home refinance can hurt your credit.
When you apply for a loan, the lender must review your credit report, which results in a “hard inquiry” of your credit. In other words, applying for a mortgage — whether to buy or refinance a home — means the lender will officially ask for a copy of your credit report, and the hard credit inquiry will cause your credit score to go down by a few points.
According to FICO, most borrowers will see a score reduction of less than five points after a single hard inquiry. A hard credit inquiry remains on your credit report for two years, although FICO only uses inquiries from the previous 12 months in its scoring calculations. However, multiple hard credit inquiries within a 12-month period can lower your credit score more significantly since borrowers with six or more hard credit inquiries are statistically more likely to declare bankruptcy.
Read more: How to know when to refinance your mortgage
Yahoo Finance tip: If you shop around for a mortgage refinance lender and apply for preapproval with different lenders, you will have more than one credit pull. This will not count as multiple credit inquiries as long as the first and last credit checks are within 45 days of each other. The credit bureaus recognize that you will only be taking a single loan and treat all hard credit inquiries within the 45-day period as a single inquiry.
If you are applying to refinance, it is impossible to avoid a small hit to your credit score due to the hard credit inquiry. But if you shop around for your loan within a focused time period, you can ensure that the damage to your credit score is minimized.
Dig deeper: Want to refinance your mortgage? Here are 7 home refinance options.
The length of your credit history accounts for about 15% of your FICO credit score. Credit history length is based on the average amount of time your current accounts have been open, the age of your newest account, and the age of your oldest open account.
This means a long-standing open account can boost your credit score, and opening several new accounts at once can lower your average credit history length and reduce your score. Also, closing your oldest open account could lower your credit score by a few points.
A refinancing loan can affect your credit history length and credit score in two ways. The first is that it will be a new loan on your credit report, partially lowering the average age of your credit accounts. Generally, this will have a negligible impact on your credit score.
The second is that if your current mortgage is one of your oldest open accounts, refinancing will not only give you a new loan but also close an old account. This could temporarily knock a few points off your credit score. However, as your refinancing loan ages, your credit score will recover.
Learn more: How to refinance your mortgage with a bad credit score
Payment history makes up 35% of your FICO score, meaning it is the most significant portion of your score. That means making consistent on-time payments is the single most important action any borrower can take to achieve and keep a good credit score.
Unfortunately, refinancing your mortgage can sometimes throw a wrench in your regular monthly payment schedule. That’s because the new lender may often tell the borrower they can skip the final payment of the original mortgage because the refinancing loan will pay it off before that payment is necessary. But if the loan payoff comes later than expected, you may miss a mortgage payment and hurt your credit score.
It’s vital for homeowners to take responsibility for paying their mortgage until the refinancing loan pays it off. Don’t make any assumptions about when the loan payoff will come through and you will avoid this potential credit score landmine.
Read more: The pros and cons of refinancing your house
Mind Your Money
Applying for a mortgage refinancing loan requires a hard credit inquiry, also known as a hard credit pull. When a mortgage lender pulls your credit, it officially requests a copy of your credit report, which is reported to the credit bureaus. This results in your credit score decreasing by a few points, generally around five.
Refinancing your mortgage will typically lower your credit score slightly because of the hard credit inquiry and the new loan’s effect on your credit history length. Most borrowers will only see their scores fall by a few points, and this effect is impossible to avoid. However, missing a mortgage payment during the refinancing process can have a larger impact on your credit score. This is an avoidable issue, though, and will not affect any borrowers who make all necessary payments before the refinancing loan pays off the mortgage.
Although mortgage refinancing can often save you money, lower your monthly mortgage payment, or shorten your repayment term, it’s not without potential pitfalls. Reducing your credit score is one negative effect, although most borrowers only see a credit score decrease of a few points after refinancing. Borrowers should also remember that refinancing comes with closing costs, and if you’re getting a cash-out refinance, you’ll use up some home equity to pay for other expenses.
This article was edited by Laura Grace Tarpley.