Manage your debt wisely to minimize impacts from refinancing on your credit score.
Mortgage refinancing can affect your FICO credit score in a few different ways. Multiple credit inquiries, how often you refinance, and whether you increase your debt can negatively impact your credit score. However, any impact would likely be small and short-lived compared to possible changes due to how you manage your debt, including making on-time mortgage payments for the duration of the loan.
The Risks of Frequent Mortgage Refinancing
While there are certain exceptions, credit rating companies may frown on your credit score getting pulled too many times over a short period -- and from too many creditors. Multiple credit inquiries from mortgage lenders -- called hard inquiries -- from shopping for refinancing can also negatively impact your credit score.
Refinancing might become problematic for your credit score if you're constantly refinancing or applying for new credit related to your mortgage. Similarly, interest-rate shopping for a refinance on your current mortgage can result in multiple credit inquiries in a short period.
The 30-45 Day Window
Fortunately, back in 2009, FICO and other credit scoring systems changed how multiple inquiries get treated on your credit score for certain kinds of debt, such as mortgages or student loans.
If you are going to shop around, FICO, created by the Fair Isaac Corporation, recommends submitting all of your applications within a 30- to 45-day period. Even if you don't accept a new loan, FICO treats all of your inquiries during that period as just one "credit pull," minimizing the impact on your score. However, FICO acknowledges that some lenders still choose to use older FICO scoring models, so some people still prefer to limit their inquiries to a 14-day period.
Limit Hard Inquiries from Lenders
Jennifer Beeston, vice president of mortgage lending at Guaranteed Rate Mortgage, suggests a workaround for the problem of multiple inquiries for a refinance.
"It is best to know your credit score," Beeston says, "and to shop lenders by giving them your score. Each lender does not have to run your credit. Once you have identified the lender you would like to work with, then have them run your credit and complete your refinance. Having one lender run your credit and refinance your home should not adversely affect your credit score."
Why Older Debt Can Be Beneficial for Your Credit Score
When you refinance an existing loan, you pay off the old mortgage loan and replace it with a new one. As a result, you may miss out on the credit benefits of a long-standing payment history with one loan. Older, established, and consistent debts tend to help your credit score, while newer debts with shorter payment histories tend to hurt your credit score.
The Drawbacks of Cash-Out Refinances
Cash-out refinances can adversely impact your credit score, including replacing the old debt with a new loan. Unlike a traditional refinance that lowers your monthly payment, a cash-out increases your payment and mortgage loan since you withdraw equity out of your home as a cash payment. As a result, your old loan gets replaced by a new loan with a higher balance.
Also, the larger loan balance from a cash-out refi could increase your credit utilization ratio, which makes up 30% of your credit score.
Your credit utilization ratio measures the amount of debt versus your credit limits. For example, if you have $10,000 in credit and $5,000 in debt, your credit utilization ratio is 50%. Ideally, many experts suggest a credit utilization of 30% or less.
Typically, the more credit available, the smaller the impact on your overall debt levels, and the less potential impact a mortgage refinance will have on your credit score.
The Bottom Line
Mortgage refinancing can negatively impact your FICO score, so it's wise to take some precautions. Try to avoid refinancing or applying for credit too frequently. Also, concentrate your credit inquiries within a short period, such as a 30- to 45-day or 14-day window when shopping mortgage rates. Work strategically with lenders to avoid having too many credit inquiries -- or hard credit pulls -- hurt your credit score. Be aware that a refinance means losing your record of paying an old mortgage on time, which could harm your score, as can a cash-out refinance.
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