You’ve decided it’s time for a home loan refinance. Great! Who doesn’t want a better interest rate? As with any loan application, though, you may be wondering whether a home loan refinance will hurt your credit score.
Solarity Credit Union prides itself on being up-front with members. Here are some factors that could cause your credit score to drop when refinancing a home loan and ways to help your credit score bounce back up.
If you’ve already closed on a home loan, you’re probably familiar with credit scores and how they work. But you may be unfamiliar with exactly how a credit score is calculated.
The first thing to know is most lenders use FICO credit scores to assess your creditworthiness. So let’s break down the math behind them.
Credit mix and new credit account for 10% each of your total FICO score, length of credit history amounts to 15%, how much debt you have accounts for 30% and payment history makes up the bulk of your FICO score at 35%. FICO also has a useful chart breaking all these percentages down.
Payment and credit history
When added together, your credit and payment history make up half your total FICO score. Your credit history refers primarily to how long your accounts have been open, including the age of your oldest and newest accounts and the average age of all your accounts combined.
The longer your credit history the better. After all, many people can make on-time payments for the first couple of months an account is open. On the other hand, showing that you’ve been able to maintain good standing for an account that is several years old is much more difficult and will, therefore, boost your credit score.
Likewise, closing an account you opened quite some time ago could cause your credit score to go down a bit. If you have other loans or credit accounts that are well established, the impact of a refinance on your credit score will likely be minimal. But if your home loan is one of your oldest open accounts, a refinance will likely cause your score to dip slightly.
The good news is that your payment history has a much greater impact on your credit score. Once you start making consistent, on-time payments toward your new loan, you will see your credit score go back up.
Let’s take a look at the second-most significant factor impacting your credit score: the amount of debt you owe. If you’re refinancing simply to get a better interest rate or extend your loan term, then you are unlikely to see a decrease in your credit score.
On the other hand, if you are doing a cash-out refi and borrowing more than you currently owe on your existing mortgage to free up some extra cash, you may see your credit score take a dip. It all depends on what you’re planning to do with that extra money.
For instance, if you want to use the money toward paying off other existing debt, then a cash-out refinance is unlikely to cause your credit score to drop much. But if you’re using the money for another reason and increasing the overall amount you owe, there’s a chance you could see your credit score sink somewhat. As you make payments toward your new loan and pay down the amount owed, however, your credit score will rise once again.
The number of hard inquiries on your credit report can also cause your overall score to drop. When we refer to hard inquiries, we’re talking about lenders pulling your credit score and credit history to determine your creditworthiness before extending you a loan. If you apply for a home loan refinance, car loan, credit card or any other type of debt, the lender is likely to request your credit history from a credit bureau, which will appear as a hard inquiry on your credit report.
Remember that new credit accounts for 10% of your overall FICO score. If you open several new credit card accounts in a relatively short period of time, FICO views you to be a slightly greater risk to creditors, causing your credit score to go down. Likewise, when your credit report reflects multiple hard inquiries, your credit score could drop as a result.
The good news, though, is that shopping around for a home loan purchase or refinance is viewed a little differently. You’re expected to shop around for the best available rate when applying for a home loan, so credit-score companies typically treat multiple hard inquiries made within a set time frame as only a single inquiry. Use timing to your advantage when applying for a home loan refinance to avoid a credit score dip. It’s generally recommended you do your rate shopping within a 30-day period.
Make sure you’re getting the best rate possible. Pull your own credit report and score before applying for a refinance. This is considered a soft inquiry and won’t impact your score. If you see your credit score could use some improvement, try to raise it with these tips before applying for a new loan or new credit.
The main thing to keep in mind when considering whether a home loan refinance will impact your credit score is that any potential drop in your credit score is likely to be short-term. In many cases, the refinance pays off in more ways than one. It literally pays off your existing mortgage, of course, but it can also pay off in terms of the benefits it provides. For instance, lower interest rates, lower monthly payments and more money in your pocket.
Solarity Credit Union helps borrowers keep what’s theirs with competitive interest rates and quality customer service. Want to see what rate you might be offered? Crunch the numbers with our refinance calculator.Once you see how much you can save, take advantage of full-service banking with a team you can trust. Speak with a Home Loan Guide at Solarity. We’ll help you start saving for tomorrow by making smart financial decisions today.