How does refinancing your mortgage impact your credit?

If you’re mulling over a mortgage refinance, it’s probably because you expect it to help your financial situation. You might be looking to convert your existing home equity into cash for a home improvement or debt consolidation. Or maybe you want to save on interest or your monthly payment. You might even want to shorten your loan term.

Does applying to refinance impact your credit score?

Yes, it’s true that applying to refinance your mortgage will cause your three-digit FICO^® Score to drop ever so slightly, at least temporarily.

While everyone’s credit report is different and it depends on your history, FICO^® says that the impact of one additional inquiry on your credit score is fewer than 5 points for most people. In terms of FICO® scores, a 5-point impact is minimal. For context, here are the credit score ranges FICO® uses:

• Exceptional: 800+
  
  
• Very Good: 740 – 799
  
  
• Good: 670 – 730
  
  
• Fair: 580 – 669
  
  
• Poor: < 580

You can think of this temporary dip in your score as credit bureaus asking you to prove your financial stability. As long as you maintain good habits like paying your bills on time and keeping little to no balance on your credit cards – referred to as low credit utilization – your score should bounce back within a few months.

Tips for protecting your credit during a refinance

While refinancing your mortgage can hurt your credit score, there are steps you can take to minimize the negative impact.

Know your credit score beforehand

Make sure you know your credit score before you begin the process of refinancing. That way, you’ll know how much it drops and will be able to tell when it’s back to where it was following your refinance.

Stay within the 14-day shopping exemption window

As mentioned, FICO^® shopping exception allows multiple lenders to run your credit within a 14-day period while only counting it as a single hard inquiry. Be sure to stay within this window to avoid any unnecessary dings to your credit score throughout the refinancing process. 

Don’t make any other changes to your credit

As you refinance, avoid making any additional changes to your credit to avoid the potential of your score dipping even more. This includes opening new accounts, buying a car or even closing old accounts.

Keep up with your monthly payments

Your payment history has the largest impact on your credit score, compared to the other factors FICO^® uses, because it shows lenders that you’re able to reliably pay back your loans. Be sure to stay on top of any monthly payments you have to keep your credit score as high as possible.

Why does refinancing hurt your credit?

Refinancing hurts your credit because the major credit bureaus figure you wouldn’t be applying for a loan if you were flush with cash. Applying for a new loan or credit is at least a weak signal that you might be overextending yourself.

There are two main ways in which refinancing your mortgage can hurt your credit score. The first is thanks to the hard credit inquiry and the second is because a refinance changed your “old debt” into “new debt.” Let’s take a closer look at what each of these actually means. 

Applying for a refinance results in a hard inquiry

Any time you officially apply for a loan or line of credit, a lender must do what’s known as a hard credit pull. This notifies the major credit bureaus that you’re applying. This is the type of inquiry that causes a small dip in your credit score.

However, there are also soft inquiries. These are checks of your credit report that don’t impact your score. This is how it works when you check your credit with sites like Rocket Homes^SM,1

Although credit inquiries stay on your report for 2 years, only inquiries in the last year impact your score. It’s a very short-term downtick.

Applying for a refinance results in new debt

Another reason why refinancing your mortgage can temporarily hurt your credit is because it turns your old debt into new debt. Your existing mortgage is considered old debt. You’ve had the chance to show you can make the payments on time, which can have a positive impact on your credit score.

When you refinance, your old mortgage loan is closed out and a new one is opened. This “new” debt is considered riskier for the lender because you haven’t had a chance to show that you can reliably make the payments. Over time, as you begin to pay your new mortgage on time, the positive credit history will help you increase your credit score.

Does rate shopping when refinancing hurt your credit score?

If you apply with five different lenders to see who offers the best deal for your mortgage refinance, are you hurting your credit with a new inquiry each time? Not so much.

FICO^® has a built-in shopping exemption. The way that this works is that if you’re clearly considering multiple lenders for the same type of loan, any inquiries made within a certain time span all count as one. Therefore, your credit score is only impacted once.

Under the versions of the FICO^® formula utilized by the major mortgage investors, you have 14 days to have your credit checked and get Loan Estimates from as many lenders as you like. It only counts as a single inquiry.

One thing to know is that this exception to the rule doesn’t apply if you have your credit checked for different types of loans. For instance, it’s not recommended that you buy a new car while qualifying for a mortgage. Not only does this count as two different inquiries, but the new car payment can screw up your debt-to-income ratio (DTI) and can potentially impact your eligibility for a mortgage.

Potential upsides to refinancing

Up to this point, we’ve been talking all about the short-term impact any credit inquiry can have on your score. But when considering whether to refinance your mortgage, it’s far more important to pay attention to how it fits in with your overall financial picture and long-term goals. To understand why, let’s look at the reasons people refinance.

Consolidate debt

It’s no secret that rates have been trending slightly higher recently. However, it’s important to note that these moves are happening across the board. While average mortgage rates are less than 7% for a 30-year fixed, the average rate for a newly offered credit card tops 18%. It makes a lot of sense from both a credit and overall finance perspective to consolidate high-interest debt. A cash-out refinance can give you the cash you need to pay off high-interest credit cards.

Fund a home remodeling project

Across much of the country, it’s a difficult market for buyers right now. Given that, many are tempted to tap existing equity in their home to add an additional bedroom or remodel the bathroom and make their existing house better fit their current lifestyle. If you can accomplish that by refinancing, don’t sweat the impact of applying.

Save money long-term

Anytime you have the opportunity to save money – whether on your monthly payment or in terms of lifetime interest on your loan – by refinancing, the credit impact is negligible when compared with the long-term gain.

Should you buy mortgage points when refinancing?

Also known as discount points, mortgage points are a type of prepaid discount on the interest of a home loan. So how much are we talking about here? A mortgage point usually costs 1% of your amount on your loan and bumps down your interest by 0.25%. So a mortgage that's $400,000 with a 7.0% interest rate will cost you $4,000 to bring down your rate to 6.75%.

While it can add up to a hefty chunk in savings, the key is to keep the loan for long enough to reach a break-even point. In other words, it's when the amount you paid in discount points and the amount you saved are the same.

You can use a mortgage calculator to figure out what your monthly payment will be on your new mortgage when you refinance. From there, you can gauge how long you'll need to keep the loan to break even with the discount points you paid for.

FAQs about how refinancing affects your credit

Still feeling unsure about how mortgage refinancing affects your credit? Check out the answers to some frequently asked questions below.

How long will it take my credit score to go up after a refinance?

This depends on your payment history for the new loan. If you make your payments on time, you should see your credit score improve within a few months. If you have trouble making your payments, your credit score will be negatively impacted even more. 

How long does a mortgage refinance stay on your credit?

As mentioned previously, the hard inquiry from your mortgage refinance will impact your credit score for a year. However, your mortgage payments after the refinance will continue to impact your score for better or worse for as long as you are repaying the loan.

Does refinancing a car hurt your credit?

Similar to refinancing your house, refinancing a car loan can have a small negative impact on your credit due to the hard inquiry and the fact that you’re swapping your old loan for a new loan. Your credit score should improve after a few months provided that you make your payments on time.

The bottom line

While applying to refinance can mean a short-term drop of a few points on your credit score, the long-term benefits outweigh the negatives if refinancing betters your financial picture. The impact to your score lasts a year at most. There’s a quick bounce back if you stick to good financial habits.

If you’re shopping around for a mortgage, you have a 2-week time frame from when your credit is first pulled to get quotes from as many lenders as you wish, so you can apply with confidence. If you’re ready to check out your options, start your application online with Rocket Mortgage^®.

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