With mortgage interest rates near all-time lows — and fears that next year could bring higher rates — now may be the time to refinance if you’ve been sitting on the fence.
“Now could be a good time to refinance, because of low rates,” says Robert Hek, Vice President of Mortgages for Morty, an online mortgage broker. “Rates are expected to rise in 2022. Landlords looking to take advantage of these rates may want to act quickly.”
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 especially beneficial when your credit score has improved since you took out the original loan, making it a popular choice for homeowners who have been in their homes long enough for the financial dust to settle and that new money-saving options open up.
But could a refi impact your credit score? If you’re wondering if refinancing a home is worth it, it’s important to weigh the potential negative effect on your credit score against the savings. Here’s what you need to know to make a decision.
4 Ways a Mortgage Refinance Affects Credit Score
According to Michelle Lambright Blackfounder of educational website CreditWriter.com.
“If you can get a lower interest rate on your mortgage, for example, refinancing might be a good financial decision,” Black says. “However, it is possible that a refinance could have a negative impact on your credit score.”
Here are some of the pitfalls to consider when it comes to refi credit score.
Refinance multiple times
Every time you refinance, a serious new inquiry is added to your credit history, according to Black. These requests represent about 10% of your FICO credit score. Your FICO score is calculated using a proprietary algorithm, Heck says, but there are some indications of the approximate impact different actions may have.
“Credit inquiries tend to be minor in terms of credit score impact,” Black says. “But there is a risk of a lower credit rating every time these credit checks take place.”
Credit score declines tend to rebound a few months after further investigation, especially if your other credit health indicators, such as credit utilization and on-time payments, are in good standing.
Refinance again in a short time
A refi loan can also impact your credit score if you refinance multiple times in a short period of time.
When shopping around, multiple inquiries about the same type of loan are usually grouped together, Heck says. However, a second rollover 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 about refinancing your home either, according to Heck. If you are considering several types of loans at the same time, you can lower your score.
Avoid opening too many lines of credit at once. When you decide to refinance your home, don’t get other loans at the same time.
“If you shop around with several different lenders, it will all be rolled into one survey,” Heck says. “Offices should not reduce this for everyone. Things get murkier if you’re looking for refinance and car loans, as well as credit cards.
Try to avoid opening multiple lines of credit in a short time, Heck recommends. Whether it’s making multiple refinance transactions or getting other types of loans at the same time you refinance.
Old debt versus new debt
Another factor that affects your credit score is the age of your lines of credit, Black points out. When you refinance, it resets the age of your loan. You end up with a newer line of credit that can negatively impact your score.
“The older the items on your credit report, the better it is from a credit score perspective,” says Black. “Refinancing adds a new business line to your credit report, which could lower your average credit age, which is generally not a good thing for your credit score.”
According to the FICO scoring model, the age of your lines of credit accounts for about 15% of your score.
How a cash-out refinance can hurt your credit score
A cash refinance could indirectly hurt your credit score if you don’t use the money to pay off other debts, Heck warns.
For example, if you use the money for a vacation or a wedding, you increase your total debt. As a result, this type of refi loan could hurt your credit score.
On the other hand, Black points out, using cash refinancing to pay off credit card debt and other loans could actually improve your overall credit score.
“When you use an installment loan, your new mortgage, to pay off revolving credit card debt, your credit utilization rate should go down,” Black says. “Using cash refinance to pay off other debts can 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 may be worth refinancing your home, even with the negative impact on your credit score. Heck and Black both point out that the savings from refinancing may outweigh the temporary damage to your credit score and some of the costs associated with refinancing.
The negative impact should be minimal, Heck says. Recovery from small gout is relatively quick.
When should you refinance your home?
Take a close look at 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 to minimize their impact on each other. For example, you might try to avoid getting a new car loan at the same time as refinancing your mortgage. Space out your loans so that they have less impact on each other.
“If you’re considering applying for new financing, like a car loan or mortgage, you might want to consider putting your refinance on hold until you’ve closed those new loans,” Black agrees. “Otherwise, a potential drop in credit rating due to refinancing could 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 could 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 temporarily find yourself with a lower credit score, it might be a smart move.
“Remember, the whole point of getting good credit is so you can use it to your advantage,” says Black. “Using your good credit to qualify for a more attractive loan could help you save money on interest and maybe even pay off your debt faster.”