Does Refinancing Hurt Your Credit Score?

If you’re a homeowner, refinancing can help you save money with a lower interest rate, cash in on your home equity, or adjust your loan terms. However, your credit score could drop in the process. Here’s what you should know about how refinancing will affect your credit, both now and in the long term, before you apply for one.

Understanding the impact of refinancing on your credit score

Refinancing a mortgage involves taking out a new loan, so this move can affect your credit in several ways. 

Credit inquiries

When you apply for a new home loan, your lender checks your credit score and credit history. The credit check will add a new hard inquiry to your credit reports, and this type of inquiry counts for 10% of your FICO credit score. Hard inquiries can lower your credit score by a few points, but the impact is usually minor and temporary. The money you save through refinancing typically outweighs the negative effects of a small credit score dip. 

Length of credit history

About 15% of your FICO credit score is based on the average length of time you've had credit accounts open. A longer credit history may lead to a healthier credit score because it allows creditors to understand how you handle debt over time. Paying off one home loan and opening a new one will shorten your average credit history, which may slightly lower your credit score. 

Amounts owed

This factor makes up 30% of your FICO credit score. Generally, having a high amount of debt may negatively influence your credit score. A rate-and-term refinance won't raise your debt level, so it may not influence this aspect of your credit score. But a cash-out refinance increases the amount you owe, which may ding your credit.

Payment history

Mortgage lenders typically report payments to the credit bureaus every month, and your payment history accounts for 35% of your FICO credit score. Even a single late or missed payment can significantly damage your credit. However, making your mortgage payments on time and in full each month can help keep your credit healthy. 

Short-term vs. long-term credit effects of refinancing

Refinancing your mortgage will impact your credit, but some effects last longer than others. For example, hard credit inquiries have a short-term effect because FICO scores only consider these for about one year. 

Increasing your debt through a cash-out refinance can have a lasting effect on your credit. But if you’re using the money to get ahead financially, such as paying off high-interest debt, it can help boost your score, says Michael Branson, CEO of All Reverse Mortgage. “Just make sure you don't rack up new debt after refinancing,” he adds.

The payment history on your mortgage can also impact your credit over many years. Making on-time payments can keep your credit healthy over time, while missed payments stay on your credit reports for seven years and can have a long-term negative credit impact.

Tips to manage your credit when refinancing

There are ways to keep your credit healthy before, during, and after refinancing. Here's how:

• Pull your credit reports before applying: Check for errors, like incorrect late payments or balances. These “can lower your score and mess with your refinance terms,” Branson says. “If you spot any issues, get them fixed before moving forward. It could make a big difference in the rates you’re offered.”
• Avoid new credit accounts: When you're refinancing, lenders will closely review your financial situation. “Opening new credit accounts can cause a temporary dip in your credit score and may make you seem riskier to lenders,” Branson says. “Stick to managing your existing credit for now and keep things steady.”
• Submit loan applications in a short time frame: Credit-scoring models know people shop for rates, so they usually treat multiple mortgage applications as a single inquiry. Consider submitting your applications within a short window, typically less than 45 days.
• Monitor your credit reports: Once you complete the refinance process, check your credit reports to confirm the old mortgage account is reported as "closed" and the new mortgage account is reported accurately. Any mistakes could negatively impact your credit score.
• Make timely payments on the new loan: Setting up automatic payments or reminders can help ensure your credit stays healthy. It can also help you rebuild any small drop in your credit score caused by refinancing. 
• Avoid closing other credit accounts: You can maintain a lengthy credit history and improve your credit utilization ratio by keeping older credit cards and lines of credit open. 
• Create a plan for your savings: If you're saving money in the refinance, consider using the money to improve your financial position. For instance, you can pay down high-interest debts or build an emergency fund.

Should you refinance? Weighing the credit implications

Refinancing can be worthwhile when it helps with your financial goals. For instance, getting a lower interest rate can help you save money and better afford the monthly payments, or a cash-out refinance might help you consolidate debt. 

While your credit score may drop in the process, it can recover if you take steps to maintain your credit.