Can Refinancing a Mortgage Lower Your Credit Score?
While paying your bills on time and maintaining a low balance are well-known ways to help you maintain your credit score, it’s less clear how refinancing your mortgage or loan affects your score. This is especially true if you are a homeowner considering refinancing to lower your monthly interest or convert existing equity into cash to pay off debts.
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There are a couple of reasons why refinancing lowers your credit score beyond the simple notion that credit bureaus assume you wouldn’t apply for a loan if you have plenty of money. Knowing the reasons that refinancing a mortgage can lower your credit score can help you decide if it’s doing so.
Why Your Score Is Lowered When You Refinance
Your application requires a hard inquiry, where the lender looks at your credit report and does a hard credit pull. Doing this brings your application to the notice of the major credit bureaus. Conversely, soft inquiries, like checking your credit for an online purchase, do not impact your score. Your report maintains hard inquiries for two years, so the best way to optimize your credit is to submit all of your lending applications together within a short period — so that one check will meet multiple needs.
How bad is a hard credit pull? FICO says one hard inquiry generally results in a point drop of 5 or lower, according to Clearview Federal Credit Union, though this is a generalization because everyone’s credit report and credit history are different. On the FICO scale, 5 points of reduction aren’t significant enough to be concerned, especially if you practice good financial habits like low credit utilization. Within a few months, your credit should return to its previous value.
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What Happens When You Refinance Your Mortgage?
Your old debt becomes new debt, in the sense that the old mortgage loan is closed and replaced by a new loan that lacks your established history of on-time payments. Without that good track record, the lender perceives more risk due to the uncertainty of whether or not you’ll make your payments on time.
Conversely, the ultimate benefit of a lower debt or monthly payment is likely to outweigh the temporary drop in your credit score. This should provide you with some assurance and not deter you from refinancing if you’ve determined it’s the right choice for you.
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This article originally appeared on GOBankingRates.com: Can Refinancing a Mortgage Lower Your Credit Score?
