“Now could be a good time to refinance, because of low rates,” says Robert Heck, vice president of mortgage for Morty, an online mortgage broker. “Rates are expected to rise in 2022. Homeowners looking to take advantage of these rates might want to move fast.”
Undergoing a mortgage refinance, aka “refi,” can be a helpful way to save money on your monthly payment and take advantage of lower rates. Refinancing is particularly beneficial when your credit score has improved since you took out the original loan, making it a popular choice for homeowners who’ve been in their homes long enough for the financial dust to settle and have new money-saving options open up.
But could a refi impact your credit score? If you’re concerned about whether refinancing a home is worth it, it’s important to weigh the potential negative effect on your credit score with the savings. Here’s what you need to know to make a decision.
4 Ways a Mortgage Refinance Impacts Credit Score
Refinancing your home can be one way to lower your monthly payment and save money on interest, according to Michelle Lambright Black, founder of the educational website CreditWriter.com.
“If you can secure a lower interest rate on your mortgage, for example, refinancing could be a good financial move,” Black says. “However, there’s a chance that a refinance might impact your credit score in a negative way.”
Here are some of the refi credit score pitfalls to consider.
Refinancing Multiple Times
Each time you refinance, a new hard inquiry is added to your credit history, according to Black. These inquiries account for about 10% of your FICO credit score. Your FICO score is calculated using a proprietary algorithm, says Heck, but there is guidance on approximately how much impact different actions can have.
“Credit inquiries tend to be minor in terms of their credit score impact,” Black says. “But there is the potential for a credit score drop whenever these credit checks take place.”
Credit score dips tend to bounce back a few months after the hard inquiry took place, especially if your other credit health indicators, such as credit utilization and on-time payments, are in good standing.
Refinancing Again In a Short Period of Time
Another way a refi loan can impact your credit score is if you refinance multiple times in a short period of time.
When you’re shopping around, multiple inquiries about the same type of loan are usually lumped together, Heck explains. However, a second refinance close to the first is a different proposition, and a lot of new activity in a short period of time is often seen as a red flag.
It’s not just refinancing your home, either, according to Heck. If you’re looking into several different types of loans at one time, you could drag your score down.
Avoid opening too many credit lines at once. When you decide to refinance your home, don’t get other loans at the same time.
“If you’re shopping around at a bunch of different lenders, all of that is going to be lumped into one inquiry,” Heck says. “Bureaus shouldn’t pull that down for each one. Things get murkier if you’re checking for refinancing, and an auto loan, along with credit cards.”
Try to avoid opening several credit lines in a short period of time, Heck recommends. Whether that’s performing multiple refinance transactions, or whether that’s getting other types of loans at the same time you’re refinancing.
Old Debt vs. New Debt
Another factor that impacts your credit score is the age of your credit lines, Black points out. When you refinance, it resets the age of your loan. You end up with a newer credit line that can have a negative impact on your score.
“The older the items on your credit report, the better from a credit score perspective,” Black explains. “Refinancing adds a new tradeline to your credit report, and that could lower your average age of credit, typically not a good move for your credit score.”
According to the FICO scoring model, the age of your credit lines account for about 15% of your score.
How a Cash-Out Refinance Can Hurt Your Credit Score
A cash-out refinance could potentially hurt your credit score indirectly if you’re not using the money to pay off other debts, Heck warns.
For example, if you use the money for a vacation or wedding, you’re adding to your total debt load. As a result, this type of refi loan could hurt your credit score.
On the other hand, Black points out, using a cash-out refinance to pay off credit card debt and other loans could actually improve your credit score overall.
“When you use an installment loan, your new mortgage, to pay off revolving credit card debt, your credit utilization rate should decrease,” Black says. “Using a cash-out refinance to pay off other debts may also reduce the number of accounts with balances on your credit report, another potentially positive credit score move.”
Is Refinancing Worth It?
Depending on the situation, it might be worth it to refinance your home, even with the negative impact on your credit score. Both Heck and Black point out that the savings from refinancing can outweigh the temporary hit to your credit score and some of the costs that come with refinancing.
The negative impact should be minimal, says Heck. Recovery from the small drop is relatively fast.
When Should You Refinance Your Home?
Carefully consider your current financial situation. If you’re worried about rising interest rates, now might be the time to start shopping around to lock in a rate before the situation changes.
Additionally, it’s important to consider your other financial goals. Heck suggests planning your loans in a way that reduces their impact on each other. For example, you might try to avoid getting a new car loan at the same time you’re refinancing your mortgage. Space out your loans so they have less of an impact on each other.
“If you do plan to apply for new financing, like an auto loan or mortgage, you might want to consider holding off on your refinance until after you close on those new loans,” Black agrees. “Otherwise, a potential credit score drop from refinancing might cause you problems.”
Is a Refinance Loan Right for You?
Black suggests using an online mortgage calculator to compare the costs of a new loan with your current loan. She points out that there might be new fees to worry about — including new closing costs — so you’ll need to calculate whether the savings will outweigh the costs. Even though you might end up with a lower credit score temporarily, it could be a smart move.
“Remember, the purpose of earning good credit is so that you can use it to your advantage,” Black says. “Using your good credit to qualify for a more attractive loan could help you save money on interest and perhaps even pay off your debt faster.”