Many people refinance their home mortgage to get a lower interest rate and reduce their monthly payments. You can also refinance your home or switch from an adjustable-rate mortgage to a fixed-rate loan. No matter what your goals are for refinancing, it’s important to think about how your credit could be impacted along the way.
When you applied for your original mortgage, your credit score likely dropped. That’s because any hard inquiry —a credit check — will knock a few points off of your score. If you’re accustomed to building credit, you know the loss of a few points goes hand in hand with getting a loan, and you’re probably not concerned by it. However, it’s not just a hard inquiry that affects your credit score—what happens after you refinance can have an impact, too.
Optimize the rate quote phase
Losing a few points from a hard inquiry is usually not a big deal. The inquiry will drop off your credit report over time and you can earn those points back.
But if you’re like most homeowners, you probably want to get the best rate possible for your new, refinanced mortgage. This usually means rate shopping with multiple lenders. This brings up an important question: will your credit score be impacted every time you get a rate quote from a lender?
The short answer is probably not. Many credit bureaus recognize when homeowners are comparing mortgage rates by the type of inquiry that shows up on a credit report. The bureaus are typically mindful of the fact that rate comparisons are necessary for a major loan like a mortgage. In fact, they ordinarily make the same allowances for car loans too.
So, as long as you do your rate shopping within a certain time period, all the inquiries are collectively recorded as one. The time period differs by scoring model, but it usually ranges from 14 to 45 days. If you’re worried about it, some experts recommend doing your rate shopping within the shorter, 14-day window.
Wait several months between loans
If you’re thinking about refinancing your home, but you just applied for a car loan a few months ago, think again.
Applying for too much new credit raises a red flag with the credit bureaus. To them, it looks like you could be reckless with your finances if you’ve borrowed significant amounts during a short time span. Granted, applying for new credit only accounts for 10 percent of your overall credit score, but small actions add up and you could inadvertently hurt your credit score as a result.
Instead, you’re better off waiting at least six months after your last loan application before you refinance your home. This gives that prior application time to settle into the background of your credit report. It also gives you time to earn back the points you lost from the inquiry.
Consider the age of your old mortgage
One thing that’s easy to forget about during a home refinance is the age of your old mortgage.
When you apply for and receive a new mortgage, your old one will close out. But if you had your old mortgage for several years, there were likely a couple of positive results for your credit:
- Your old mortgage bumped up the average age of all your credit accounts.
- You built up a lengthy payment history with it.
Closing the old loan means you’re starting over with a brand-new loan that has no payment history associated with it yet. Since both credit age and payment history are factored into your credit score, your score can drop when that old mortgage goes away. The average age of your credit decreases and that old payment history will no longer be working in your favor.
Of course, some of these negatives to your credit may be unavoidable. That’s why it’s important to carefully weigh how a refinance could affect you, especially if you’re hovering between a good and an average credit score.
Think about the big picture
There are lots of reasons to refinance your home. But it’s not a decision to make casually if you have any worries about your current credit or financial situation. Before you decide, factor in all the financial commitments and conditions of a refinance:
- Make sure you understand what you’re getting into. Refinancing early in your mortgage might make more sense considering that you’re mainly paying interest at that point. Refinancing later is like starting over with another 30-year loan.
- Use a mortgage calculator to compare your current mortgage’s interest rate and monthly payments with that of your new loan. Will the cost savings be significant enough that it makes sense to move forward?
- Don’t forget to add in all your fees. Mortgage refinances come with closing costs including application, origination, and appraisal fees. That amounts to a large amount of cash you’ll need to have on hand.
On a positive note, time is your ally when it comes to credit. Over time, the negative effects of a loan process will lessen, and you can significantly raise your credit score if you make all your payments as expected. In fact, since payment history accounts for the largest percentage of your credit score, the most important thing you can do for your credit is to keep up with your mortgage payments.
Finally, check your credit report
Like going to the dentist, many people either avoid their credit report or forget to check it regularly. Your credit report gives you valuable insight into your overall credit health. It reveals errors and inaccuracies that you may not have known about, but which could be impacting your credit score. Knowing what’s in your report helps you when it’s time to refinance your home or apply for any other loan.