When interest rates started to drop in the spring of 2020, my husband and I took notice.
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.
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.
A lower rate … and a lower credit score, temporarily
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.
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.
• 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. Big balances on your credit card could increase your credit utilization ratio.
• Make sure you know when your first new mortgage payment is due: Sometimes your new loan can be sold to a different lender before you even make your first payment. Missed or late payments can greatly affect your credit score.
The good outweighs the bad
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.