Can refinancing a mortgage negatively impact your credit?

Refinancing a mortgage is a common financial move that homeowners make to secure better interest rates, lower monthly payments, or tap into home equity. However, if you’re considering refinancing, you might wonder how it will affect your credit score. Will it hurt your credit, or could it actually improve it? In this blog, we’ll break down how refinancing impacts your credit and what you should consider before making the decision.

What is Mortgage Refinancing?

Refinancing a mortgage means replacing your current loan with a new one, usually with different terms. Homeowners typically refinance to lower their monthly payments, reduce their interest rates, or consolidate debt. Sometimes, refinancing is done to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, or to cash out equity for other financial purposes.

Does Refinancing Hurt Your Credit?

The short answer is: It can affect your credit, but whether it hurts or helps depends on how you manage the process. Let’s take a look at the factors involved.

1. Hard Inquiry Impact

When you apply to refinance your mortgage, lenders will perform a hard inquiry (also known as a hard pull) on your credit report. This is a standard procedure to assess your creditworthiness. A hard inquiry typically causes a small drop in your credit score—usually a few points. The effect is temporary, and your score will likely recover in a few months if no other negative events occur on your credit report.

2. New Credit Account and Average Age of Accounts

If your refinancing involves a completely new loan with a different lender, this will show up as a new account on your credit report. Opening new credit accounts can lower the average age of your credit accounts, which may slightly affect your credit score, especially if your credit history is relatively young. However, the impact of this drop is usually minimal and tends to fade as your account ages.

3. Debt-to-Income Ratio and Credit Utilization

Refinancing a mortgage doesn’t directly affect your credit utilization rate—the ratio of your available credit to the amount you’re using. However, if you refinance to access home equity through a cash-out refinance, you could potentially increase your debt. This could affect your debt-to-income ratio, a key factor in your creditworthiness. If your debt rises significantly and you struggle with payments, your credit score could be negatively impacted in the long run.

4. Paying Off Existing Mortgage

On the flip side, refinancing your mortgage may also improve your credit score in the long term if it helps you manage your debt more effectively. For example, if refinancing allows you to lower your monthly payments and avoid missed or late payments, it can have a positive effect on your credit. Additionally, if you pay off your previous mortgage balance as part of the refinancing, you could see a boost to your credit score since it reduces your overall debt load.

5. Potential for Better Financial Management

A lower interest rate or lower monthly payment can also make it easier for you to stay on top of your finances. If you refinance and manage your payments responsibly, this can contribute to a stronger credit history over time. Positive payment history is the single most important factor affecting your credit score.

How to Minimize the Negative Impact

If you’re concerned about how refinancing will affect your credit, there are steps you can take to minimize any negative impact:

• Shop Around Within 30 Days: Multiple hard inquiries from mortgage lenders within a 30-day window are typically treated as a single inquiry by credit bureaus. This means you can shop around for the best refinancing rate without damaging your credit score too much.
• Keep Your Credit Utilization Low: Avoid making large purchases on credit or accumulating other debt while refinancing. Keeping your credit utilization low will help maintain a positive credit profile.
• Make Timely Payments: Be sure to keep up with your payments on the new mortgage and any other debts you have. Payment history is the most important factor in your credit score.

Conclusion

Refinancing your mortgage may cause a temporary dip in your credit score due to hard inquiries and potential changes in your credit profile, but it doesn’t necessarily hurt your credit in the long run. In fact, if managed well, refinancing could improve your credit by making it easier to stay on top of payments and reduce your overall debt.

Before refinancing, take the time to weigh the pros and cons, consider how it will affect your credit, and shop around for the best deal. If done right, refinancing can be a smart financial move that helps you save money and improve your credit in the long term.