Mortgage rates have hit an all-time low this month, which means there's never been a better time to refinance your mortgage to take advantage of low rates.
But if you're worried about your financial future—and who isn't? —refinancing a mortgage loan comes with some big questions. Will a re-fi affect your credit score? And if so, is it still worth it?
Here's what you need to know about precisely what happens when a lender pulls your credit report.
Factors That Determine Your Credit Score
Your credit report contains a wealth of information about your finances, including your lending history and the credit cards in your name. This information is used to determine your FICO Score, which is a grading system that shows lenders how good a risk you are. The higher your credit score, the more likely a bank is to want to lend to you because they're confident you'll pay the loan back.
Credit scores can feel mysterious, especially since three companies calculate them, and each may have a slightly different figure for you. But in general, they all follow a similar breakdown. Here are the categories that affect your score and how heavily they are weighted:
- Payment History: 35%
- Amount of Debt Owed: 30%
- Length of Credit History: 15%
- Credit Mix: 10%
- New Credit: 10%
Whenever you open a new credit card or loan—or apply for a mortgage refinance—the lender pulls a credit report to check your score. This inquiry is recorded on your credit report, where it stays for two years. In addition, any inquiries made within the last 12 months are calculated in your FICO score and typically result in a credit score drop of 5 to 10 points. This drop is temporary, and on-time payments—the most critical category—will bring it back up in short order.
It's important to note that the "new credit" category is only 10 percent of your total credit score, and your mortgage lender will be well aware that they are the ones who caused that slight dip in the first place. What lenders are looking for is a pattern: If you opened dozens of credit cards or loans over the past year, all those inquiries would be a red flag. But a slight dip from rate shopping shouldn't make or break your application.
Other Ways Refinancing Can Affect Your Credit Score
When you refinance, you technically pay off your old mortgage and open a new one. This means that you'll have a newer loan on your credit history—one with a very short on-time payment history. This could affect your credit score by altering your credit mix and the length of your credit history calculation. This effect could be slightly negative or neutral, as these aren't the highest impact categories for your credit score.
On the bright side, a refinance that lowers your payment could ultimately help improve your credit score, as you now have support in making payments on time and in full, month after month. Likewise, a lower monthly payment could encourage you to pay a little extra each month, which will more quickly lower the ratio of debt owed. These are the two most relevant categories that make up your credit score, so the potential for improvement could promptly offset the ding from the initial inquiry.
The Bottom Line
A mortgage refinance might affect your credit score by temporarily lowering it by a few points when you first apply. However, the value of the money you save with a lower interest rate and the potential to boost your score through on-time and extra payments far outweighs the brief dip.
To learn more about refinancing your mortgage, get in touch with Wyndham Capital today.
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