Mortgagerateslocal.com – If you are a homeowner, you might have considered refinancing your mortgage at some point. Refinancing is when you replace your existing loan with a new one, usually with a lower interest rate and/or a shorter term.
Refinancing can help you save money on your monthly payments, reduce the total interest you pay over the life of the loan, and even access some of the equity in your home.
But before you decide to refinance your mortgage, you should be aware of how it can affect your credit score. Your credit score is a numerical representation of your creditworthiness, based on the information in your credit reports.
It reflects how well you manage your debt, pay your bills on time, and use your available credit. Your credit score can influence your ability to qualify for loans, credit cards, and other financial products, as well as the interest rates and terms you are offered.
Does Mortgage Refinancing Affect FICO Score?
Refinancing your mortgage can have both positive and negative impacts on your credit score, depending on how you go about it and how you handle your new loan. We will explain how refinancing can affect your FICO score, which is one of the most widely used credit scoring models in the U.S.
We will also give you some tips on how to minimize the potential damage and maximize the potential benefits of refinancing your mortgage.
How Refinancing Can Lower Your FICO Score
There are a few ways that refinancing your mortgage can lower your FICO score, at least temporarily. These include:
- Hard inquiries: When you apply for a new loan, the lender will check your credit report and score to assess your creditworthiness. This is called a hard inquiry, and it can lower your score by a few points. However, the impact is usually minor and short-lived, as hard inquiries only stay on your credit report for two years and only affect your score for one year. Moreover, FICO treats multiple inquiries for the same type of loan within a 45-day period as a single inquiry, so you can shop around for the best rate without hurting your score too much.
- New account: When you close your old loan and open a new one, you are creating a new account on your credit report. This can lower your score in two ways: by reducing the average age of your accounts, which is a factor in your credit history, and by adding a new debt obligation, which is a factor in your credit mix. However, these effects are also minor and temporary, as your new account will age over time and your credit mix will diversify with other types of credit.
- Balance increase: When you refinance your mortgage, you might end up with a higher loan balance than before, depending on the fees and closing costs involved. This can lower your score by increasing your debt-to-income ratio, which is a measure of how much of your income goes toward paying your debt. However, this effect is also negligible and temporary, as your balance will decrease as you make your monthly payments.
How Refinancing Can Raise Your FICO Score
There are also some ways that refinancing your mortgage can raise your FICO score, especially in the long run. These include:
- Lower interest rate: When you refinance your mortgage to a lower interest rate, you can save money on your monthly payments and reduce the total interest you pay over the life of the loan. This can help you improve your score by freeing up more cash flow to pay off other debts, such as credit cards, personal loans, or student loans. Paying down your revolving debt can lower your credit utilization ratio, which is a measure of how much of your available credit you are using. This is one of the most important factors in your credit score, and keeping it below 30% can boost your score significantly.
- Shorter term: When you refinance your mortgage to a shorter term, such as from a 30-year to a 15-year loan, you can pay off your debt faster and save money on interest. This can help you improve your score by reducing your debt-to-income ratio and increasing your credit history. Having a longer and more positive credit history can increase your score, as it shows that you are a responsible and reliable borrower.
- Cash-out option: When you refinance your mortgage, you might have the option to take out some of the equity in your home as cash. This is called a cash-out refinance, and it can help you improve your score by using the money to pay off high-interest debt, such as credit cards, personal loans, or student loans. As mentioned above, paying down your revolving debt can lower your credit utilization ratio and boost your score. However, you should be careful not to use the cash for unnecessary or frivolous expenses, as this can increase your debt and lower your score. You should also be aware that a cash-out refinance can increase your loan balance and lower your home equity, which can affect your score negatively.
How to Minimize the Negative Effects of Refinancing
If you decide to refinance your mortgage, there are some steps you can take to minimize the negative effects on your credit score. These include:
- Shop around: When you are looking for the best rate and terms for your new loan, you should shop around and compare offers from different lenders. This can help you find the best deal and save money on interest and fees. However, you should also limit your rate shopping to a short period of time, preferably within 45 days, to avoid multiple hard inquiries on your credit report. As mentioned above, FICO treats multiple inquiries for the same type of loan within a 45-day period as a single inquiry, so you can shop around without hurting your score too much.
- Maintain your old loan: When you are in the process of refinancing your mortgage, you should continue to make your monthly payments on your old loan until the new loan is closed and funded. This can help you avoid missing or late payments, which can lower your score significantly. Missing or late payments can stay on your credit report for seven years and affect your score for as long as they are there. Therefore, you should always pay your bills on time and in full, as this is the most important factor in your credit score.
- Avoid closing old accounts: When you refinance your mortgage, you might be tempted to close your old loan account or any other credit accounts that you no longer use. However, this can lower your score by reducing the average age of your accounts and increasing your credit utilization ratio. As mentioned above, having a longer and more positive credit history can increase your score, as it shows that you are a responsible and reliable borrower. Moreover, having more available credit can lower your credit utilization ratio, as it shows that you are not using all of your credit. Therefore, you should keep your old accounts open and active, as long as they do not charge you any fees or interest.
How to Maximize the Positive Effects of Refinancing
If you decide to refinance your mortgage, there are also some steps you can take to maximize the positive effects on your credit score. These include:
- Use the savings wisely: When you refinance your mortgage to a lower interest rate and/or a shorter term, you can save money on your monthly payments and reduce the total interest you pay over the life of the loan. You should use this extra money wisely and strategically to improve your financial situation and your credit score. For example, you can use the savings to pay off high-interest debt, such as credit cards, personal loans, or student loans, which can lower your credit utilization ratio and boost your score. You can also use the savings to build an emergency fund, invest for retirement, or save for a major purchase, such as a car or a vacation, which can improve your financial security and stability.
- Use the cash-out option carefully: When you refinance your mortgage, you might have the option to take out some of the equity in your home as cash. This can help you improve your score by using the money to pay off high-interest debt, as mentioned above. However, you should use the cash-out option carefully and sparingly, as it can also hurt your score by increasing your loan balance and lowering your home equity. You should only use the cash for necessary or beneficial expenses, such as home improvements, medical bills, or education costs, which can increase the value of your home or your income. You should also avoid using the cash for unnecessary or frivolous expenses, such as shopping, gambling, or vacations, which can increase your debt and lower your score.
- Make your new payments on time: When you refinance your mortgage, you should make sure that you can afford the new monthly payments and that you pay them on time and in full. This can help you improve your score by establishing a positive payment history on your new loan, which is the most important factor in your credit score. Paying your bills on time and in full can also help you avoid late fees, penalties, and interest charges, which can save you money and reduce your debt.
How to Monitor Your Credit Score After Refinancing
After you refinance your mortgage, you should monitor your credit score regularly to see how it changes over time and to catch any errors or discrepancies that might occur. You can check your credit score for free from various sources, such as your bank, your credit card issuer, or online platforms, such as Credit Karma, Credit Sesame, or WalletHub. You can also get a free copy of your credit report from each of the three major credit bureaus, Equifax, Experian, and TransUnion, once every 12 months through AnnualCreditReport.com.
You should review your credit score and report carefully and look for any changes or issues that might affect your score. For example, you should check if your old loan account is closed and your new loan account is opened, if your loan balance and payment history are accurate, and if there are any hard inquiries or new accounts that you did not authorize. If you find any errors or discrepancies, you should dispute them with the credit bureau and the lender as soon as possible, as they can lower your score and hurt your credit reputation .
How to Maintain and Improve Your Credit Score After Refinancing
After you refinance your mortgage, you should also take steps to maintain and improve your credit score in the long run. This can help you qualify for better rates and terms on future loans, credit cards, and other financial products, as well as save money on interest and fees. Some of the best practices to maintain and improve your credit score after refinancing are:
- Pay your bills on time and in full: As mentioned above, this is the most important factor in your credit score, and it shows that you are a responsible and reliable borrower. Paying your bills on time and in full can also help you avoid late fees, penalties, and interest charges, which can save you money and reduce your debt. Moreover, paying your bills on time and in full can also help you avoid negative marks on your credit report, such as delinquencies, collections, or foreclosures, which can lower your score significantly and stay on your report for seven years or longer .
- Keep your credit utilization low: As mentioned above, this is one of the most important factors in your credit score, and it shows how much of your available credit you are using. Keeping your credit utilization low can boost your score significantly, as it shows that you are not overextending yourself and that you have enough credit to handle unexpected expenses. A good rule of thumb is to keep your credit utilization below 30%, and ideally below 10%, of your total credit limit. You can lower your credit utilization by paying off your revolving debt, such as credit cards, personal loans, or student loans, or by increasing your credit limit, such as by requesting a higher limit from your credit card issuer or opening a new credit card account .
- Maintain a good credit mix: As mentioned above, this is a factor in your credit score, and it shows how diverse your credit portfolio is. Having a good credit mix can increase your score, as it shows that you can handle different types of credit, such as installment loans, revolving loans, and mortgages. However, you should not open new credit accounts just to improve your credit mix, as this can lower your score by creating hard inquiries and reducing the average age of your accounts. You should only open new credit accounts when you need them and when you can afford them .
- Avoid closing old accounts: As mentioned above, this can lower your score by reducing the average age of your accounts and increasing your credit utilization ratio. Therefore, you should keep your old accounts open and active, as long as they do not charge you any fees or interest. You can keep your old accounts active by using them occasionally and paying them off in full every month. This can help you maintain a longer and more positive credit history, as well as a lower credit utilization ratio, which can boost your score .
Conclusion
After you refinance your mortgage, you should monitor your credit score regularly and look for any changes or issues that might affect your score. You should also take steps to maintain and improve your credit score in the long run, such as keeping your credit utilization low, maintaining a good credit mix, and avoiding closing old accounts. By doing so, you can enjoy the benefits of refinancing your mortgage and improve your financial situation and your credit reputation.
