The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.
Refinancing a mortgage or adding any new inquiries to your credit profile can affect your credit, but the impact is usually temporary. Many people consider refinancing to lower their monthly payments and free up additional funds for other expenses, even at the risk of affecting their credit. Keep reading to understand how refinancing a mortgage can hurt your credit and what measures you can take to protect it.
What is refinancing?
Refinancing refers to taking out a new loan to pay off your old one. For example, if you owe $100,000 on a $200,000 mortgage, you can take out a new loan to pay off the existing balance. You then start making payments on the new loan.
There are numerous reasons you might consider refinancing your mortgage, including:
- Getting a lower interest rate if your credit score or the market has improved since taking out the last loan
- Changing the terms of your current loan to reduce monthly payments
- Being approved for more than what you owe to cash out the difference and cover a large expense
Having good credit is very helpful for getting approved for a new loan. You should also consider factors such as how much you’ll owe in closing costs and how refinancing can affect your credit, especially if this isn’t your first time. Constantly transferring your mortgage to new loans can cause some harm as well as good.
Can refinancing a mortgage hurt my credit?
Refinancing a mortgage can hurt your credit in a few ways. Although refinancing can also improve your financial situation, consider the following factors before making definitive decisions.
Credit checks
When a lender checks your credit report, it’s referred to as a hard inquiry, which can temporarily drop your credit a bit. The more hard inquiries you accrue within a span of several weeks or months, the worse it usually is for your credit.
Accumulating too many inquiries can make you seem like a desperate borrower, which is a red flag for many lenders. Hard inquiries can remain on your credit report for about two years, but they typically only impact your score for up to 12 months.
Closing a loan account
Paying off your existing mortgage by refinancing closes that account and eventually clears it from your credit report. While this may seem harmless, one of the factors that determines your overall credit score is length of credit history.
Your credit history length is calculated based on how long your accounts have been established. This includes the age of your oldest account, the age of your newest account and the average age of all open accounts combined. Length of credit history accounts for 15 percent of your FICO® score, if your current mortgage has a lengthy history, refinancing it could temporarily hurt your credit.
Multiple loan applications
Some people apply to several lenders when refinancing to find the best loan terms and lowest interest rates. Every time you submit an application, the lender checks your credit report, triggering a hard inquiry against your account. To keep these hard inquiries from hurting your score, submit all loan applications within a short time frame.
Credit scoring models understand that many consumers rate shop when seeking loans and often group certain inquiries occurring within a period of 14 – 45 days as one event. This can minimize damage to your credit as long as the inquiries are for the same type of loan.
How to protect your credit when refinancing your mortgage
If you decide refinancing your mortgage is the best move for your financial well-being, closing your existing account before opening a new one is unavoidable. However, there are steps you can take to minimize the impact on your credit.
Check your score beforehand
Check your credit score before starting the refinancing process. Your score heavily influences whether a lender will approve you for a loan and what interest rate you’ll receive. According to FICO, a good credit score falls between 670 and 739. Mortgage lenders typically look for a score of 620 or higher before approving a loan, but a score of 760 or higher can help you qualify for the best interest rates.
If your score is lower than 620, you may want to wait until it improves before refinancing. Even if you aren’t approved for the loan, the lender evaluation still counts as a hard inquiry, and you would risk decreasing an already low credit score. This could affect your ability to access other types of credit.
Additionally, check your score after refinancing to evaluate the damage and track the recovery process. If your score is lower than expected or you notice any unfamiliar inquiries, consider seeking credit repair.
Weigh the pros and cons
Refinancing often temporarily hurts your credit, and it’s usually not enough of a difference to cause long-lasting or serious credit damage. However, refinancing may not be worth it if it doesn’t actually save you money. Use a mortgage calculator to test potential refinancing rates and see how they affect your monthly payment. If refinancing carries great financial benefits, moving forward may be best for your situation.
Additionally, determine how much you expect to pay in closing costs or other fees. Refinancing may not be the best move if you end up paying more in closing costs than you expect to save by opening a new loan.
Keep up with monthly payments
Payment history has the largest impact on your credit report, accounting for 35 percent of your total FICO score. Submitting applications for new mortgage loans doesn’t mean you can stop paying your existing loan. Keep making monthly payments until the old account is officially paid off with the new loan and closed.
Failing to make a payment or paying late can lower your score and cause future lenders to view you as unreliable. Some people stop making payments on an existing loan once refinancing is pending due to fear of overpaying or wasting money. However, lenders are required to refund the difference if the amount they receive is larger than what you owe on an existing loan.
Once your mortgage officially transfers to the new loan, continue making on-time payments to get your credit back to where it was prior to refinancing. Consistently paying bills in full and by their due dates is the most effective way to alleviate credit damage.
Avoid making other changes to your credit
When refinancing, avoid making additional changes to your credit to prevent your credit from dropping even further. For example, don’t open a new credit card or refinance a vehicle at the same time you’re shopping around for new mortgage loans. Even if all these actions occur within a short period of time, credit scoring models will count them as separate inquiries because they’re different types of credit.
If you’re considering mortgage refinancing, choose a time when you haven’t recently applied for a different type of credit and have no plans to make other changes. This prevents too many inquiries from hitting your credit report simultaneously, minimizing the impact on your credit health.
How long does it take to improve your credit after refinancing your mortgage?
After refinancing your mortgage, your credit will likely dip slightly, but only temporarily. How long it takes to improve your credit score depends on your payment history for the new loan and whether you gain more hard inquiries from other types of credit after opening a new mortgage.
If you consistently make on-time payments and refrain from making additional changes to your credit, your credit should improve in a few months. However, if you struggle to make payments, accrue other debts or notice unexpected activity on your credit report, credit repair could help get your finances back on track.
Lexington Law can address inaccurate or negative items on your report to determine the best way to rebuild your credit. Get started with a free credit assessment today.