Here’s What Mortgage Refinancing Can Do To Your Credit Score
This article is reproduced with permission from Nerdwallet.
When interest rates started to drop in the spring of 2020, my husband and I took notice. We have observed that both fixed and variable rate mortgage rates continue to fall to historically low levels. As more and more friends told each other how much they had lowered their rates and monthly payments, we decided to consider refinancing.
Mortgage refinancing involves taking out a new loan to replace your existing loan. The most common reason for doing this, especially now with extremely low rates, is to lower your monthly payment.
Locking in a lower interest rate through refinancing can save money on your monthly budget. And those savings add up to a substantial amount over time. According to Freddie Mac, FMCC,
borrowers who refinanced to lower their rates or extend the term of their loan saved on average nearly $ 2,300 in annual interest during the first quarter of 2020.
But refinancing your mortgage could have an unintended downside: your credit score could take a hit. The good news, however, is that the drop is temporary and your score should rebound. Here is what I noticed when I refinanced my mortgage.
A lower rate… and a lower credit rating, temporarily
When we started shopping around for rates on a new mortgage – it’s best to get a few quotes to find out your options – we knew creditors would check our credit reports. We knew this would result in a “serious investigation” of our reports, which would likely result in a drop in our credit scores by a few points.
We have learned that although a few different creditors will retrieve your reports as you shop for interest rates, multiple inquiries when shopping for rates over a short period will usually be combined into one request. This way the effects on your score are minimized.
After freezing a low rate and signing a big stack of papers, we were the proud owners of a brand new mortgage. We traded our 30-year mortgage for a 15-year loan at a much lower interest rate, and were able to reduce the number of years we will be making payments. I was delighted with the money we were going to save. But I wasn’t as excited about what happened to my credit score.
About a month after closing, I noticed that my FICO FICO,
the score fell by more than 30 points. My VantageScore dropped 13 points. These two main credit scoring models take many of the same factors into account when calculating your credit score, but weigh them a little differently. The things that affect your scores are:
- Payment history: Are you paying your bills on time?
- Use of credit: How much of your credit limits are you using?
- Sales: How much do you owe overall?
- Credit age: What is the average age of all your accounts?
- Types of credit: Do you have a mix of revolving accounts, like credit cards, and installment loans, where payments are equal and run for a set period of time?
- Recent inquiries: How many hard draws do you have on your credit?
I had a good history of on-time payments, an acceptable credit mix, and recent inquiries on my report were minimal. Once the new loan appeared on my credit report, the biggest drag on my score was that the new loan balance was, of course, 100% of its original amount.
Unfortunately, when you refinance, information about your previous loan amount that you paid back is not kept. You will also likely reduce the overall age of your accounts by replacing an old account with a brand new one.
3 ways to minimize the impact on your credit
There are steps you can take to protect your credit during the refinancing process:
- Think of interest rate buying as a sprint, not a marathon: When looking for the lowest rates, submit all your requests within 14-45 days so they can be processed as one credit request. The new FICO scoring models allow a period of 30 to 45 days, but some older FICO scoring methods still in use limit the window to 14 days. VantageScore also uses a 14 day window.
- Don’t plan another large purchase around the same time: If you’re planning to buy a new car or finance a major purchase with a credit card, plan your purchases around your mortgage refinancing. Buying a car or opening a new credit card will cause more difficult draws on your report, which will further lower your credit score. Large balances on your credit card could increase your credit utilization rate and hurt your score.
- Make sure you know when your first new mortgage payment is due: Refinancing your mortgage can be a lengthy and detailed process. Sometimes your new loan may be sold to another lender before you’ve even made your first payment. Be clear about when your payment is due and to whom to send it. Missed or late payments can greatly affect your credit score.
Good outweighs evil
For me, and for many people, refinancing for a lower interest rate mortgage is the right decision. Any money saved over time by reducing the monthly payment or reducing the term of the loan will far outweigh any damage to the credit score. The downgrade in credit rating is temporary and the numbers should continue to rebound as the new loan is paid off.
Stacie Charles has refinanced her home in Texas more than once in the 12 years she has lived there and has experienced a drop in her credit rating each time, up to 40 points: “My ratings fell as soon as the new mortgage appeared on my credit report. But she saw her credit scores improve several months after the refinancing, and they were fully restored after four to six months.
Before you refinance, do the math to make sure it makes sense to you. But don’t let the fear of a temporary drop in your credit score keep you from locking in lower interest rates. Minimize the negative effects as best you can, and know that as long as you continue to manage your credit wisely, your scores will recover.
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Erin Hurd is a writer at NerdWallet. Email: [email protected]