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When interest rates started to drop in the spring of 2020, my husband and I took notice. We watched as the rates on both fixed-rate and adjustable-rate mortgages continued to slide to historic lows. As a growing number of friends gushed about how much they’d lowered their rates and monthly payments, we decided to look into refinancing.
A mortgage refinance is when you take out a new loan to replace your existing loan. The most common reason to do this — especially now with rock-bottom rates — is to lower your monthly payment.
Locking in a lower interest rate by refinancing can save some serious cash in your monthly budget. And those savings add up to a substantial sum over time. According to Freddie Mac, borrowers who refinanced in order to lower their rate or extend the term of their loan saved an average of nearly $2,300 in annual interest during the first quarter of 2020.
But there could be an unintended downside to refinancing your mortgage: Your credit score might take a hit. The good news, though, is that the dip is temporary and your score should bounce back. Here’s what I noticed when I refinanced my mortgage.
» MORE: Should I refinance my mortgage?
A lower rate … and a lower credit score, temporarily
When we started shopping around for rates on a new mortgage — it’s best to get a few quotes so you know your options — we knew that the creditors would check our credit reports. We knew that this would show up as a “hard inquiry” on our reports, which would likely ding our credit scores by a few points.
We learned that even if a few different creditors pull your reports while you’re interest rate shopping, multiple inquiries while rate shopping over a short time frame will usually be lumped together into just one inquiry. That way, the effects on your score are minimized.
After locking in a low rate and signing a fat stack of papers, we were the proud owners of a brand-new mortgage. We traded our 30-year mortgage for a 15-year loan at a much lower interest rate, and successfully slashed the number of years we'll be making payments. I was ecstatic about the money we’d save. But I wasn’t quite as excited about what happened to my credit score.
About a month after closing, I noticed that my FICO score dropped more than 30 points. My VantageScore fell 13 points. These two main credit scoring models consider most of the same factors when calculating your credit score but weigh them a bit differently. The things that affect your scores are:
Payment history: Are you paying bills on time?
Credit utilization: How much of your credit limits are you using?
Balances: How much do you owe overall?
Age of credit: What’s the average age of all your accounts?
Kinds of credit: Do you have a mixture of revolving accounts, like credit cards, and installment loans, where payments are equal and run for a set period?
Recent inquiries: How many hard pulls on your credit do you have?
I had a good history of on-time payments, an acceptable mix of credit and the recent inquiries on my report were minimal. Once the new loan showed up on my credit report, the biggest drag on my score was that the new loan’s balance was, of course, 100% of its origination amount.
Unfortunately, when you refinance, the information about how much of your previous loan you had paid off doesn’t carry over. You also likely will lower your overall age of accounts by replacing an older account with a brand-new one.
3 ways to minimize the effects on your credit
You can take steps to protect your credit during the refinance process:
View interest rate shopping as a sprint, not a marathon: When you shop around for the lowest rates, submit all of your applications within 14 to 45 days so they can be treated as a single credit inquiry. Newer FICO scoring models allow a 30- to 45-day period, but some older FICO scoring methods that are still in use limit the window to 14 days. VantageScore also uses a 14-day window.
Don’t plan another large purchase around the same time: If you’re planning on buying a new car or financing a large purchase on a credit card, time your purchases around your mortgage refinance. Buying a car or opening a new credit card will result in more hard pulls on your report, which will further drop your credit score. Big balances on your credit card could increase your credit utilization ratio and cause your score to take a hit.
Make sure you know when your first new mortgage payment is due: Refinancing your mortgage can be a lengthy and detailed process. Sometimes your new loan can be sold to a different lender before you even make your first payment. Be clear on when your payment is due and whom to send it to. Missed or late payments can greatly affect your credit score.
The good outweighs the bad
For me, and for many people, refinancing to a lower interest rate mortgage is the right move. The money saved over time by reducing the monthly payment or slashing the length of the loan will far outweigh any credit score damage. The credit score dip is temporary, and the numbers should continue to bounce back the more the new loan is paid down.
Stacie Charles has refinanced her Texas home more than once in the 12 years she’s lived in it and experienced a dip in her credit score each time, by as much as 40 points: “My scores dropped as soon as the new mortgage showed up on my credit report.” But she saw her credit scores creep back up several months after the refinances, and they were fully restored after four to six months.
Before refinancing, do the math to make sure it makes sense for you. But don’t let the fear of a temporarily decreased credit score stop you from locking in lower interest rates. Minimize the negative effects as best you can, and know that as long as you continue to manage your credit wisely, your scores will recover.