Does Refinancing Affect Credit Score?

Refinancing involves replacing an existing loan with a new one, often to secure more favorable terms such as a lower interest rate, a different repayment schedule, or to access equity. This financial action can apply to various types of debt, including mortgages, auto loans, or student loans.

Immediate Credit Score Impacts of Applying

When a consumer applies for a refinance loan, lenders typically perform a “hard inquiry” to assess creditworthiness. This process involves accessing the applicant’s credit report from one or more of the major credit bureaus. A hard inquiry is recorded on the credit report and can cause a temporary, minor dip in a credit score, usually by about five to ten points. The impact of such an inquiry is generally short-lived.

Credit scoring models, such as FICO and VantageScore, recognize that consumers often shop around for the best loan terms. To accommodate this “rate shopping” behavior, multiple inquiries for the same type of loan within a specific timeframe are often treated as a single inquiry for scoring purposes.

For example, FICO models typically allow a 45-day window for mortgage, auto, and student loan inquiries, while VantageScore models may use a 14-day window. However, this special treatment for rate shopping generally applies only to installment loans like mortgages, auto loans, and student loans, not to revolving credit accounts such as credit cards. Therefore, it is advisable to complete loan shopping within the shortest common window, which is 14 days, to ensure the inquiries are grouped.

Impact of New and Closed Accounts on Credit History

Refinancing involves closing an existing loan account and opening a new one, which can influence various components of a credit score, particularly the length of credit history and credit mix. The length of credit history, which accounts for approximately 15% of a FICO Score, considers the average age of all accounts. Opening a new loan account can lower the average age of accounts, as a younger account is added to the credit profile.

When an old loan account is closed due to refinancing, its payment history generally remains on the credit report for up to ten years, which can continue to positively influence the score. However, the closure of an older account might eventually reduce the average age of accounts as it ages off the report, potentially affecting the score over the long term. Closing an account does not immediately remove its history, but it can alter the overall age calculation in the future.

Credit mix, accounting for about 10% of a FICO Score, evaluates the diversity of credit types an individual manages, such as a combination of revolving accounts (like credit cards) and installment loans (like mortgages or auto loans). A new refinance loan may affect the credit mix if it introduces a different type of credit to the borrower’s profile. However, since refinancing typically replaces one type of installment loan with another, the impact on credit mix is often minimal unless the loan type fundamentally changes.

Influence of Loan Balances and Payments on Credit Scores

The new loan’s balance and the borrower’s subsequent payment behavior are significant determinants of credit score changes post-refinancing. The “amounts owed” category, which makes up about 30% of a FICO Score, considers the total amount of debt an individual carries and their credit utilization on revolving accounts.

A new, potentially larger loan balance, particularly in the case of a cash-out refinance where equity is converted to cash, can increase overall debt levels. This increase in debt could negatively impact the “amounts owed” factor, especially if the cash is not used to pay down other existing high-interest debt.

Conversely, if funds from a cash-out refinance are used to consolidate or pay off other higher-interest debts, such as credit card balances, it can lead to a reduction in overall credit utilization and potentially improve the credit score. While the new mortgage balance might be higher, reducing other revolving debt can have a positive effect on the “amounts owed” category. This strategic use of refinance funds can lead to an initial sharp improvement in credit scores.

Payment history is the most impactful factor in credit scoring, accounting for 35% of a FICO Score and up to 40% of a VantageScore. Consistent, on-time payments on the new refinance loan are important for building and maintaining a strong credit score. Conversely, missed or late payments, even a single payment delayed by 30 days or more, can severely damage a credit score and have a lasting negative impact. The long-term trajectory of a credit score after refinancing is largely determined by the borrower’s diligence in making all payments on time.