Can Refinancing your Home Hurt your Credit?
There are many reasons why you may think about refinancing your home. But before you begin the process, you should consider the many ways your credit score can be impacted. The impact to your credit score starts with the application process and includes the way that the loan is recorded. Additionally, the loan increases your debt-to-credit ratio and closes your old mortgage account. There is even the danger of missing a payment. All of these actions can negatively impact your credit score.
What to Consider When Refinancing
There are numerous reasons why you might consider when refinancing your home. Perhaps you need to prevent foreclosure on your property. Maybe you’re looking to consolidate your debt. Or the opportunity to switch from an ARM to a fixed rate mortgage has presented itself. It could be something as necessary as getting the cash you need for home improvements. There are many reasons why you might want to refinance your home but it is important to understand that this is a serious financial decision. And important financial decisions demand that you understand all the associated benefits, risks, costs and consequences. In this article, we will be looking at how home refinancing impacts your credit rating.
Refinancing and Credit Score
Most people know that their credit rating impacts their options when it comes to major financial decisions. The most common piece of advice given to people seeking to refinance their home is that a credit check is their first step. Though you may determine that you have a good credit score, how would the creditor know that? Obviously, you could tell them; perhaps provide a hard copy from a reputable source as evidence. But in reality, you can understand that the creditor— being asked to entrust you with a large sum of money—would be inclined to make an independent inquiry. And this is the first point where refinancing your home can impact your credit.
These are known as hard inquiries; they typically result in your credit score being lowered by a few points. The inquiry itself signals that you’re looking for new credit to other creditors. Too many of these inquires suggests that you are desperate for that new credit. For many creditors, that desperation doesn’t make you look like a safe credit risk. That is why some people in the loan industry suggest triggering these inquiries within a short period (e.g. 14 to 45 days). Potentially, this would result in all inquiries made being counted as only one inquiry in your credit score calculations. Though the caveat to this is that it depends on the scoring model and type of loan you are seeking. The best advice is that you should only apply for refinancing when you’re serious about following through with the application. If you are interested in shopping around for rates, do so within a two week period.
Now we’ve shown you how the initial credit check can impact your credit score, but it doesn’t stop there. There are other ways that refinancing your home can impact your credit score. One of those ways depends on how the loan is reported. That is: Is the loan reported as a modification of your original home loan, or is it being considered as an entirely new loan. If it is the former (i.e. a modified version of your original loan) then there are three things that will impact your score: the credit inquiry (which we have already discussed), changes to the loan balance, and any changes in loan terms. In this particular case, the loan’s impact on your credit score should be minimal. But if the loan is reported as being new, then a fourth variable (in addition to the previous three) will
impact your credit score. This fourth item is a new open date that is treated as a new credit obligation. If your home refinancing loan is reported in this way, then it will have a greater impact on your credit score.
Other Ways that Impact your Credit Score
But these are not the only ways that refinancing your home can have a negative impact on your credit score. Fundamentally, home refinancing is an increase in the amount of debt you owe. The amount of debt you owe to creditors accounts for 30% of the calculation used to determine your credit score. Increasing your debt also increases your debt-to-credit ratio while decreasing your credit score.
Another possible way that your credit could be impacted is related to the above scenario where refinancing your home is reported as a new item on your credit report. When you refinance your home, you are effectively paying off your old loan. The problem here is that older accounts demonstrate a degree of reliability to creditors. When you close the old account of your existing home loan, you are replacing an old account with a new one.
The final way that refinancing your home could impact your credit is through a missed payment. Home refinancing is a lengthy process. But you will need to keep up with the payments of your original mortgage, and be very clear on when the first payment of your new loan is due. It is not unusual for borrowers to miss a payment for either of these loans. Sometimes a payment is missed during the transition from one loan to another through no fault of the borrower. Whatever the case, you need to make sure that those payments are made on time, or your credit score will take a hit.