How does mortgage refinance affect your credit score?
Mortgage refinance affects your credit score because it will take a hit, however temporarily, each time you complete a credit application. New debt amount, credit inquiry, and length of credit history each contribute to that hit. The following is a breakdown of how mortgage refinance affects your credit score:
Credit inquiry. When a lender conducts a hard credit check after you submitted a credit application for a refinanced home loan (or a credit card), it will lower your credit score temporarily. Of your credit score, hard credit inquiries comprise 10%. If you complete numerous applications within a shorter time period, that signals to credit bureaus that you are shopping for the best rates. Completing fewer applications several months apart, however, may be counted as separate inquiries, each of which could cause a brief dip in your credit score.
Average age of your credit history matters. Since mortgage refinance can appear on your credit report as a new loan, it will drop the average age of credit history. Of your total credit score, the age of your credit history comprises 15%. Shorter credit history signals to potential lenders and creditors that you are inexperienced in managing credit, even though making payments promptly and accumulating new credit is good for your credit score in the long term. It is not the biggest factor, but it does affect your total score.
How is your credit score calculated?
The majority of mortgage lenders use the Fair Isaac Corporation, or FICO, credit score to determine credit risk. You can predict what may happen if you refinance if you know your FICO score. According to FICO, your score is calculated in the following way:
35% – payment history
30% – amounts owed
15% – length of credit history
10% – new credit
10% – credit mix
Both the length of your credit history as well as your credit will be impacted when you refinance. If you opt for a cash-out refinance, it could also affect the amount of debt you owe. The financial benefits of refinancing outweigh the negatives—although it is important to note you will take a temporary credit hit.
Being hit by hard credit inquiry
To ensure you qualify for a given product, a lender will conduct a hard credit inquiry any time you apply for a mortgage or any credit. Your credit score will likely be impacted temporarily after the inquiry is recorded on your credit report. Of your FICO score, new credit comprises 10%. Multiple hard inquiries could have a broader effect but one inquiry will likely drop your credit score by five points.
How to protect your credit score
Here are some ways to protect your credit score when refinancing:
Timing. Homeowners usually think about refinancing to lower their monthly payments when interest rates dip. Refinancing makes the most sense, mortgage experts agree, if you can lower your interest rate by at least 0.75%.
Because you will pay closing costs when refinancing, you might consider if you will be in the house long enough to recoup that expense. If you save $200 per month by refinancing, for example, but pay $4,000 in closing costs, that would take you 20 months to break even.
Credit check yourself. This is a good thing to do before applying to see if you would qualify for a new loan. It should be noted: soft inquiries like this do not affect your credit.
Space out refinancing. FICO scores take into account inquiries from the past 12 months only; hard inquiries remain on your credit reports for up to two years. That means you might want to wait at least a year before refinancing again if you have done so recently. Doing so means new credit inquiries will not accumulate with the first refinancing.
Do not open more credit accounts. It is a good idea to stop using credit until you close on refinancing. In the meantime, you can keep your credit strong by tackling your high-interest debts and paying your bills promptly.
Compare offers. Shop. Submit applications with a few different lenders and compare their offers. It is always a great strategy for saving your money. The key to shopping around like that is to submit multiple inquiries within a specific time period to avoid negatively impacting your score.
Tips on how to prepare for refinancing your home
The following are good things to keep in mind when getting ready for a refinance:
Check your credit history. You can do this through either of the major credit bureaus or for free through your credit card issuer or your bank.
Clean up errors. There is a chance that your credit report is lower than it ought to be due to derogatory or false marks. You can dispute these by contacting a credit bureau.
Get pre-qualified. Source the best offer for you by shopping around with multiple lenders.
Organize your paperwork. Prior to finishing your application, prepare your financial documents and tax forms.
Complete application. This step can be completed after you have decided on a lender who offers the best repayment terms and interest rate for you.
Keep paying your current loan. The process of repaying your current loan is incomplete until your new refinancing lender tells you so.