Does Refinancing Hurt Your Credit Score?

You can lower your monthly payment, reduce your interest rate or shorten or lengthen the term of your loan by refinancing your existing mortgage, car, student or personal loan to a new one. These are all important financial benefits. But what about your credit score? Does refinancing a loan hurt your credit score?

Yes, it will. But only slightly and only temporarily. And the benefits of a mortgage refinance and other refinances usually far outweigh the small hit to your score.

How exactly does your refinance impact your three-digit FICO credit score? Here is an in-depth look at what refinancing will and won’t do to your score.

Refinancing And Your Credit Score: At A Glance

• Refinancing a mortgage and other loans can cause your three-digit FICO score to fall, but only by a small amount and only temporarily.
• Your score falls because of what’s known as a hard inquiry, a credit inquiry to make sure you’re likely to afford your refinance. A hard inquiry usually causes your credit score to drop by no more than five points, and only for a short time.
• The benefits of refinancing, such as a lower monthly mortgage payment, typically outweigh the small hit to your credit score.
• If you shop around with several lenders in a short period of time, the hard inquiries these lenders make when pulling your credit reports will only count as one total inquiry. This means that you won’t get punished for shopping for the lowest interest rates and fees.

5 Reasons To Consider Refinancing

You can refinance most loans, including mortgages, student loans, personal loans and auto loans. While there are several reasons to refinance an existing loan, most people do so to lower the interest rate on their debt, something that will lower their monthly payment.

Sometimes, you might refinance to pay off debt, perhaps taking out a cash-out refinance on your existing mortgage and using the extra cash from it to pay off your higher-interest-rate credit card debt.

Here are some of the most common reasons to consider refinancing:

1. Your interest rate is  high: Most people refinance to lower the interest rate on a loan. Maybe you have a 30-year, fixed-rate mortgage with an interest rate of 7%. If your credit has improved since you first applied for your mortgage, you might refinance to lower that interest rate to 6% or 5%, which will make your mortgage less expensive.
2. You want to reduce your monthly payment: Maybe you’re paying off an auto loan that comes with a $400 monthly payment. If you refinance that loan to one with a lower interest rate, you might reduce that payment to $300 a month, depending on how much lower your new interest rate is.
3. Your loan’s term is too short: Maybe you are paying off a 15-year, fixed-rate mortgage. Because this mortgage has a relatively short term, you’ll pay more each month to pay it off. If you refinance to a mortgage with a 30-year term, you’ll spread your payments out over a longer number of months, meaning that each monthly payment will be smaller. This could help if you are struggling with cash-flow issues.
4. You want the lower interest payments that come with a shorter-term loan: While longer-term mortgages such as a 30-year, fixed-rate home loan come with lower monthly payments, they are also more expensive over time. That’s because you’ll pay hundreds of thousands of dollars more in interest if you take the full 30 years to pay off such a mortgage. If you refinance to a shorter-term loan, such as a 15-year mortgage, you’ll pay far less in interest. Just make sure you can afford the higher monthly payments.
5. You need cash to pay off other debts or fund a home improvement: You can turn to a cash-out refinance of your mortgage if you need access to a large amount of cash. In a cash-out refinance, you refinance for more than what you owe on your mortgage. Say you owe $250,000. You might refinance to a new mortgage for $320,000, depending on how much equity you’ve built in your home. You’d then take the extra $70,000 as cash that you can spend however you’d like. You’d repay the total $320,000 in monthly mortgage payments with interest.

What Happens When You Apply To Refinance – And How It May Drop Your Credit Score

When you apply for a refinance, your mortgage lender will check your three credit reports, one each maintained by the national credit bureaus of Equifax^®, Experian™ and TransUnion^®. These reports contain your key personal and financial information, such as the balances on your credit cards and loans and any late or missed payments you’ve made in the last seven years. They’ll also contain negative judgments such as any foreclosures or bankruptcies you’ve claimed in the last seven to 10 years.

The information in these credit reports make up your three-digit FICO score. This score sums up how well you’ve managed your credit and paid your bills, and ranges from 300 to 850. Most lenders consider a FICO score of 740 or higher to be a very good one and 800 and higher to be excellent. If your score falls in those ranges, you’ll generally qualify for loans and credit cards with the lowest interest rates.

Lenders Perform Hard Credit Checks

When lenders check your credit reports, it’s known as a hard credit inquiry,  a way to tell lenders and credit card providers that you are looking either for a new loan or credit card. These inquiries remain on your credit reports for two years, according to credit bureau Equifax. One hard inquiry will cause your score to fall, but only by a small amount. Equifax says that after a year, a hard inquiry will typically no longer have any effect on your score. If you have several hard inquiries for different types of loans and credit in a short period, your score will fall by a greater amount.

You Wind Up With New Debt

When you refinance a loan, you are replacing an older loan with a newer one. This could have a small negative impact on your credit score because the FICO scoring model prefers old debt that you already have a history of paying down each month over new debt on which you haven’t yet started to make regular payments.

You might be increasing your total debt

If you opt for a cash-out mortgage refinance, you’ll be adding to your total debt. Say you refinance a mortgage with a balance of $200,000 into a new loan with balance of $280,000, taking the extra money as cash. You’ve now added $80,000 to your total debt load, which could cause your credit score to fall, at least temporarily.

How Much Applying For A Refinance Hurts Your Credit Rating

How much refinancing hurts your credit score depends on a variety of factors, including how strong your credit score was before you applied for a refinance.

Credit bureau Experian says that a lender’s hard inquiry from a refinance application will usually drop your credit score by no more than five points. Experian says, too, that your score should recover from this quickly, usually within a few months, if you continue to make your payments on time and pay down your credit card debt.

How Long It Takes For Your Credit Score To Recover

The small drop in your credit score from a hard inquiry doesn’t last long, either. Experian says that your score should recover from this quickly, usually within a few months, if you continue to make your payments on time and pay down your credit card debt.

Looking For The Best Deal Doesn’t Hurt Your Credit Report

The credit bureaus don’t want to punish you for shopping around with several lenders for the best interest rates and fees. If you ask for refinance quotes from five lenders during, say, a 10-day period, the credit bureaus will treat the five hard inquiries from these lenders as one inquiry. That’s because you will eventually apply for just one loan, just after shopping among five lenders to get it. Equifax says that if you are shopping for one type of loan during a short period – usually 14 to 45 days – the several hard inquiries that lenders make on your credit will be treated as just one inquiry.

4 Ways To Protect Your Credit Score When Refinancing

Want to lessen the hit on your credit score? Here are some steps to minimize the damage that refinancing can cause.

1. Look Up Your Credit Score First

It helps to know how strong your credit score is before you apply to refinance your mortgage. You can pay for your credit score from FICO and each of the three credit bureaus. But you can also find free versions of your credit score, often from your bank, credit union or credit card providers. This might not be the exact same score that lenders use, but it will give you an idea of whether your score is solid or weak.

You can also turn to the Rocket Money app to get your free credit scores. Click here to learn more about accessing your credit scores through the free Rocket Money app.

2. Maintain A Solid Payment History

The best way to maintain a strong credit score, even with a hard inquiry on your credit reports, is to make your monthly payments on time. Every time you pay your mortgage, auto, student or personal loans on time, or make an on-time payment on your credit card bill, your lenders and creditors will report it to the national credit bureaus. A history of on-time payments will steadily boost your credit score.

3. Take Advantage Of The 14-Day Window

If you’re shopping for a mortgage, auto or other loan, make sure to contact the lenders you are considering within a 14-day window. That’s the easiest way to guarantee that any hard inquiries that these lenders make will be considered as just one inquiry on your credit reports.

4. Avoid Changing Your Credit Profile 

Don’t apply for several new credit cards when also applying for a mortgage. Don’t apply, either, for personal loans during this time. Your credit score will take a hit if you apply for several new forms of credit or debt at the same time.

FAQs About How Refinancing Affects Credit Scores

How long will a hard inquiry keep lowering my credit rating?

Credit bureau Experian says that your credit score should usually recover within two months if you maintain a record of on-time payments on your other debt and credit.

Will I get a hard credit check every time I apply for a refinance?

If you shop around with several lenders during a short period – usually 14 to 45 days – and each of these lenders performs a hard credit check, the bureaus will consider it as just one hard inquiry. But, yes, when you apply for a refinance at least one hard inquiry will show up on your credit reports.

How many points will my credit score drop if I apply for a refinance?

This varies, but you can expect your credit score to temporarily drop by no more than five points when a lender performs a hard inquiry when you apply for a refinance.

Is refinancing worth having my credit score drop?

That depends. If you can save significant money by refinancing or reduce the amount of interest you are paying on a loan? Then the financial benefits of a refinance are probably worth the slight and temporary hit to your credit score.

The Bottom Line: Refinancing Will Lower Your Credit Score Temporarily 

Though refinancing will typically lower your credit score, the drop is small and temporary. Don’t let that small drop keep you from enjoying the financial benefits that a lower interest rate, smaller monthly payment or different loan term can bring. If you are interested in learning more about how moves such as refinancing can help you master your finances, download the Rocket Money app. Once you do, you can access your credit scores, craft a budget and learn how to best manage your monthly payments.