Does Refinancing a Mortgage Hurt Your Credit Score?

Jaron Pak
A laptop's screen is open to a mortgage refinance application.

It’s always important to consider your credit score when making large financial decisions, especially when it comes to borrowing money in significant quantities. This is as true for refinancing as it is for anything else.

If you’re considering refinancing your mortgage, it’s good to be aware of the fact that it will affect your credit score, and not in a good way, either.

Even if you’re borrowing funds in a responsible manner, in an effort to lower your interest over the course of your mortgage, refinancing still consists of taking out a new loan to replace an old one. Unfortunately, no matter how you present it, it’s an activity that never looks great on a credit report.

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Refinancing Your Mortgage

Refinancing your mortgage is a process in which you take out a new home loan, typically with better interest rates and overall more beneficial terms, and then use it to pay off your existing mortgage.

People refinance their mortgages for a variety of different reasons, such as:

  • Lowering your mortgage interest rate by taking advantage of current rates that are lower.
  • Extending the period of your loan to reduce your monthly payments.
  • Shortening the period of your loan to lower the total amount of interest paid over the term of the loan.
  • Shifting from an adjustable-rate mortgage to a fixed-rate mortgage to lock in a lower rate.
  • Getting rid of existing mortgage insurance expenses on your current loan.
  • Using a cash-out refinance to liquidate some of your home’s equity into cash.

While all of these are legitimate reasons to refinance your home, they must be weighed against the negative effects of opening up a new loan.

For instance, when refinancing, you must continue living in your current home long enough to break even on the expense of the refinancing itself. This can often cost thousands of dollars, which may take months and even years to recuperate.

In addition, if you bought your home or already refinanced in the recent past, you may be incurring unnecessary expenses by refinancing too soon.

Probably the biggest problem with refinancing, though, is the negative effect that it can have on your credit score.

Downsides to Refinancing a Mortgage

While there are plenty of pros and cons that come with refinancing, the impact it will likely have on your credit score is purely one of the “cons.” Below are some of the different ways that refinancing can negatively impact even a good credit score.

Credit Check        

As you shop for various quotes, each lender will have to conduct a credit inquiry. Credit checks of this nature lower your credit score.

Fortunately, if you conduct all of your quote shopping within a narrow window of time, the FICO credit score model will consider them all one single inquiry. The window of time to shop is either 14 or 45 days, depending on whether each banking institution is using the old or new model respectively.

To be safe, it’s generally recommended to keep things within a two-week limit. While this will still hurt your score, it won’t be as bad as counting each credit check individually.

Closing an Account

When you refinance, your new loan is used to pay off an existing mortgage. While this is good as far as the refinance is concerned, all the credit bureaus see is that you’re shutting down an existing account and opening up a brand new one.

The problem is, older credit typically boosts your credit score, while new lines of credit drag it down.

Home Equity

Homeowners often refinance a mortgage to tap into their home equity, which is a perfectly reasonable thing to do — until you consider your credit score.

Your score is dependent on your credit utilization ratio, which should typically remain under 30% if possible. As you draw on your equity and turn it into cash, it can quickly have an adverse effect on your credit score.

Multiple Loan Applications

Refinancing — or submitting any kind of mortgage-related financial application, such as a home equity loan or line of credit — too often can be detrimental to your credit score.

Financial institutions can get uncomfortable when they see this kind of erratic behavior. In addition, each loan application comes with a new round of the negative activities listed above, all of which drive your credit score lower and lower as you go along.

Should I Refinance My Mortgage?

The question that remains is if you should refinance your mortgage or not. While there are a variety of different considerations that should factor into this decision, your credit score should certainly be one of them.

As such, your credit score is generally going to fall onto the “con” side of the ledger when you’re considering a refinance. It should slip right in alongside negative considerations such as wanting to move in the near future or the fact that you recently opened up your mortgage in the first place. All of these are significant reasons to avoid refinancing a mortgage no matter how alluring the current rates may be.

From opening new lines of credit to increasing your credit utilization ratio and even causing multiple credit checks, there are many ways that a mortgage refinance will hurt your credit score.

The good news is, if you conduct your refinancing activity in a responsible manner and maintain financial integrity before, during, and after the process, the entire affair should ultimately have a short-lived effect on your overall credit score. In fact, if the refinance doesn’t significantly alter something significant such as your credit utilization ratio, your score may even correct within a few months of your refinance.

Of course, your credit score isn’t the only factor in question, either. If there are enough other positive reasons, such as lowering your interest rate, shortening your loan period, or even locking in a fixed-rate mortgage, it still may be worth taking a temporary hit on your credit score in order to cash in on other benefits.

The important thing is that you continue to pay your mortgage throughout the process, regardless of which loan is in effect, as failing to do so will have a far worse impact on your credit score than simply refinancing a mortgage.

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