Towards the end of 2024, applications to refinance mortgages kept banks busier than ever. As of September 2024, there was a 94% year-over-year increase in mortgage refinances. If you plan to join the millions of Americans refinancing their mortgages, you’ll want to prepare yourself. Most importantly, you’ll need to make sure your credit is in a good place. Keep reading to learn how credit impacts your refinancing process and get tips on getting your credit to where it should be.
What is Refinancing a Mortgage?
Some people mistakenly think refinancing a mortgage is easier than your initial mortgage application. And in some ways, that might be true. You now have some history of making mortgage payments, which can work in your favor.
But, a refinance is a new loan application. When you refinance, you replace your existing loan with a new one. This means you must reapply and be approved for the loan at the new terms you’re asking for.
People refinance their mortgages for several reasons, including:
- They want to secure a lower interest rate.
- They want to extend the total loan period to lower their monthly payment.
- They want to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage or vice versa.
- They want to access their home equity to finance other large expenses, such as renovations, a second property, or emergency medical bills.
Credit Score Impacts on Mortgage Refinancing Options
Your credit score significantly impacts your refinancing. Specifically, your score will come into the refinancing process for both the approval and interest rate.
Approval
Since this is a new loan, you’ll have to apply and get approved for your refinanced mortgage. As you likely know from your first mortgage application, your credit score plays a major role in securing an approval. If your score has gone down drastically since you were originally approved for a mortgage, there’s a possibility you can get denied for refinancing.
Interest Rate
Your credit score will tie directly to the interest rate you receive on your mortgage loan when refinancing. A low credit score makes you seem like a riskier borrower to the lender, so they offset said risk by charging you a higher interest rate. And since your mortgage is typically a larger loan, this difference in rate is monumental.
A one percent difference in your interest may not sound like a lot. But let’s compare a 3% and 4% interest on a $160,000 mortgage loan. The 4% loan means your monthly payment is $100 more monthly, which adds up to an estimated $30,000 more in interest over a 30-year term. That type of difference is precisely why people prioritize getting their credit scores in shape before applying for a new or refinanced mortgage.
3 Ways Refinancing Impacts Your Credit Score
In addition to your credit score mattering to the loan application process, there’s another role your credit plays in all of this. The actual application process itself can impact your credit in three ways:
- New Loan: As a reminder, refinancing means closing out one loan and taking out another. So, your old account will be closed out on your credit report, and a new loan will appear as a line item. Your credit age accounts for 15% of your credit score. If your old mortgage was one of your older credit accounts, your average credit age will dip when you close the account. As a result, your credit score might see a slight dip. However, this impact will be reversed as time passes and your average credit age goes back up.
- Multiple Inquiries: If you’re shopping around for the best rate, you’ll incur numerous hard inquiries on your credit report. Hard inquiries typically drop your credit score a few points, but multiple inquiries close together can significantly impact your score. However, you can usually have several hard inquiries within a short period (typically 14-45 days) be treated as a single inquiry on your credit report. This is specifically done so consumers can compare rates from different lenders without drastically impacting their score.
- Skipped or Missed Payments: Even after you’ve been approved for a refinance, it can take some time for your lenders to switch everything over. Some people make the mistake of missing a mortgage payment on their old loan because they think everything has successfully switched before it really has. A missed payment can become a negative line item on your credit report and drop your score by several points.
What’s a Good Credit Score for Refinancing?
Most experts say you need a minimum credit score of 620 to get approved for refinancing. So, aim to have your credit score at least this high before you start the process. Although, even higher would be ideal to get you the lowest interest rate possible.
How to Fix Your Credit Quickly
The good news is that your credit score isn’t permanent. You can start taking action today to boost your score. If you have the flexibility, consider putting off the refinance for a few months to a year while focusing on improving your score. If you can get your FICO credit score to the “very good” level (740-799), you’ll probably be offered the best interest rate available to consumers when you apply.
Here are some steps you can take to start improving your credit immediately:
- Pay Bills on Time: Every missed payment can harm your credit. Put as many bills on autopay as possible to never miss another payment.
- Decrease Your Debt: A healthy credit utilization ratio of 30% or lower benefits your credit score. You’ll need to keep your total debt down to maintain a good credit utilization ratio.
- Dispute Credit Errors: Get a copy of your recent credit report from each major credit bureau and review them thoroughly. If there are any errors, dispute them immediately.
- Keep Old Accounts Open: Even if you stopped using a credit card, consider keeping it open to keep your credit age high.
Refinancing a mortgage can be a wise financial move. However, just like you prepared for your original mortgage loan, this step will require some planning. Improve your credit before you apply for refinancing to ensure the best possible outcome.
You might also be interested in: 10 Best Practices for Managing Your Credit Utilization
