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June 28, 2019

Does Refinancing Hurt Your Credit? The Process, the Impact, and Your Alternatives

If you're a homeowner with a mortgage, you've probably thought about refinancing. Maybe it's because you wanted to take advantage of lower interest rates or switch from an adjustable rate mortgage to a fixed rate option. Or maybe you wanted to cash out some of your equity to pay for things like home improvements or your child's college education.

The idea of saving money and having more cash is tempting, there's no doubt about that. But as you know, no financial boost is without its risks. One of the primary risks of refinancing, other than the possibility that you'll default on your new loan, is that applying for and taking out a new mortgage could hurt your credit.

Let's take a look at why.

What is refinancing?

Refinancing a mortgage means switching out your original loan for a new one that has different terms. The new mortgage pays off the old one, so you're still only making payments on one loan. Ideally, that new loan will improve your financial picture in the long run.

Does refinancing affect your credit?

It can, but the degree of impact depends on your personal financial situation and history.

The Fair Isaac Corporation, more commonly known as FICO, weighs five factors to determine your credit score. These include your payment history, account balances, length of credit history, number of new accounts, and mix of credit types.

 
Refinancing is most likely to affect your credit age, new account ratio, and account balances. Here's how.

New credit

If your lender reports your refinanced mortgage as the new loan with changes in terms, it won't affect the age of your credit. But if it's reported as a new loan, your credit report will reflect that new debt.

FICO considers the age of all your accounts, which includes the age of your oldest account and the age of your newest. If your report shows a brand-new mortgage, that automatically skews your average account age. Also, because your older mortgage has been paid off, you no longer have that older account to balance out the new one.

Higher balances

If you have equity built up in your home, you may choose to take some of that equity as cash when you refinance. That can get you out of a tight spot, but be aware that it's not free money. The originator of your new loan will add that amount to your balance. 

Remember, the amount you owe accounts for 30 percent of your credit score. If your mortgage balance ends up significantly higher, your score could take a hit. 

Hard credit inquiries

Lenders usually check your credit when you apply for mortgage refinancing. This is known as a hard inquiry, which means that you prompted the credit check when you applied for the loan.

A hard inquiry happens every time you apply for a loan, but they won't all necessarily affect your credit score. When you request mortgage rates from multiple lenders within a 45-day period, FICO acknowledges this as “rate shopping” and considers them all to be a single inquiry. 

One inquiry may still cause your credit score to drop, particularly if you've recently applied for other loans. Also, if you take longer than 45 days to do your rate shopping, you'll have more than one inquiry on your record and your score will drop more.

Missed payments

It's not uncommon for a borrower to miss a mortgage payment while in the process of refinancing. This often happens because the borrower understands that the new loan will cover the upcoming payment on the new loan. Then the new loan's first bill comes out after the due date for the old loan and credit bureaus consider that to be a late payment.  

To avoid this, make sure that your first payment on your new loan is made before your prior due date.

What does a lower credit score mean?

Lenders check your credit because it helps them to determine how risky a borrower you are. A lower score tells them that you've missed payments, taken on a lot of debt, or depended too heavily on one type of loan. A lender may make up for that risk by charging you higher interest rates or denying you a loan in the first place.

It's easy to believe that if you're able to get your refinance, you won't need a good credit score. But it takes time to build your score back up again – usually months if not years. You're far better off not letting your score drop in the first place. 

Alternatives to refinancing

If you're asking yourself, "Does refinancing hurt your credit score?" and thinking the answer might be yes, look at whether you can achieve your financial goals another way. For instance, if you're hoping to lower your interest rate, consider: 

  • Negotiating with your lender 
  • Requesting a lower rate from a different creditor 
  • Paying off credit cards or other debt accounts to reduce interest growth.

If you're planning a cash-out refinance, there might be other ways to get the money you need. Home equity loans and lines of credit also let you tap your equity, but these are also loans and could lower your credit score for the same reasons that refinancing would.

Selling your home is another way to get access to your home equity, but it doesn't always leave you ahead financially. Moving is expensive and if you choose to buy rather than rent your next home, you're still facing closing costs even if you downsize. 

Moving can also be an emotionally weighty proposition, especially if you're already feeling the stress of financial difficulties.

Don't sell and move – Sell and Stay!

There's now a way to get your equity without a loan and without having to leave the home you love. EasyKnock developed the Sell and Stay program so that homeowners could sell their property and remain in place as tenants, paying rent to the company until the right time came for them to relocate or re-purchase their homes.

The best of both worlds

With Sell and Stay, you get relief from your mortgage as well as cash in hand. You can use that money to pay off other debts or simply get your budget back on track. And without the threat of having to move looming over your head, you can take your time and make financial decisions with a calm mindset. Contact EasyKnock today and find out how to get started.

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