How refinancing your mortgage can affect your credit

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Refinancing your mortgage can help reduce your monthly payments, help you consolidate debt, or provide a way to pay off your home loan faster. There are several benefits to refinancing a mortgage, but oftentimes borrowers forget to consider how doing so could impact their credit score. In today’s post, we’ll review how refinancing can affect your credit and how to determine whether or not it’s worth the potential risk.

What is Refinancing?

First, let’s talk about refinancing. Refinancing is when a borrower takes on a new loan to cover the remaining balance of their previous loan, typically at a lower interest rate or with more favorable terms. Here are a few example refinancing scenarios:

A mortgage borrower with a variable interest rate refinances into a more secure fixed rate mortgage, avoiding having to pay more when the variable rate adjusts.

A mortgage borrower refinances into a mortgage with a lower interest rate, lowering their monthly mortgage payments.

A mortgage borrower refinances for more than what they owe on their mortgage and receives the difference in cash, i.e. a cash-out refinance. They can use the cash to pay off other debts, fund home renovation projects, or however else they wish.

How Refinancing Can Affect Your Credit

When you apply for a refinance loan, your mortgage lender will check your credit score and history. This triggers what’s known as a hard inquiry, which is a credit inquiry that has the potential to lower your credit score and thus, can only occur with your permission. Each new inquiry shows up on your credit report and accounts for 10% of your overall FICO score. Therefore, when you apply for a refinance, you could see a few points taken off of your score. While this may not be enough to drastically lower your score, you should be aware of the possibility. If you’re right on the cusp of having a qualifying credit score, even a small loss could tip you below where you need to be.

Keep in mind, the longer you shop for refinancing rates, the more likely you are to negatively impact your credit rating. If you’re rate shopping within a short timeframe (less than a month), multiple loan applications will usually show up as a single inquiry on your credit report. However, if you spend several months shopping for loans, multiple inquiries could appear, each one knocking down your score. This could significantly diminish your score and make it difficult to get approved for credit in the future.

Paying Off Your Mortgage

When you refinance your mortgage, you’re essentially paying off or ‘closing out’ your old home loan with a new one to replace it. Since the age of your debt matters in calculating your FICO score, closing out your old home loan could actually work against you. If you don’t really need to refinance, and you plan on buying a new home in the near future, it may not be worth the risk of losing ground on your credit report.

Read related article, “Should I Refinance Near Retirement?”

Drawing Home Equity

If you choose to tap into your home equity through a Home Equity Line of Credit (HELOC) or a home equity loan, this will increase your debt load and therefore could affect your credit score. Your debt accounts for 30% of your FICO score, so taking on more debt could mean a solid hit to your credit report.  In some cases, it may be worth it. In other cases, maybe not. It’s up to each individual borrower to decide if they are willing to risk their credit score for the ability to access their home equity.

Is it worth it?

There are some instances in life when losing a few points on your credit score is inevitable. And there are some cases in which the long term savings is totally worth the short term loss. While we cannot decide for you, we encourage our readers and borrowers to carefully explore their financial options when considering a mortgage refinance. Every borrower’s scenario is different and what may make sense for one person may not be ideal for everyone.

If you’re interested in learning more about refinancing your mortgage, please don’t hesitate to contact us. We will review your scenario and offer advice based on your unique needs and budget.

 

Disclaimer: The information presented in this post is for educational purposes only and is not to be taken as professional credit advice. Consult a credit professional or financial counselor for more information.

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