Interest rates have taken a hit in 2020, a hit that is saving homeowners thousands of dollars a year.
Mortgage rates are lower than ever, so you can refinance and save even if you have only had your current mortgage for a few months. To get the lowest rate possible, you need to maintain a good credit score, which can become more difficult after refinancing.
In fact, when you refinance, your credit can easily go down. Here are three reasons why, along with some solutions to soften the blow.
1. It leads to multiple “hard” inquiries.
Every time you apply for a new loan, your lender asks for your credit history from one of the three major credit bureaus, Equifax, Experian, or TransUnion. This is a “hard inquiry”, typically it remains on your file for 24 months and will automatically lower your credit score.
You will definitely want to store around and compare rates to get the best deal. A study by mortgage giant Freddie Mac found that if you compare five mortgage lenders, you’ll pay an average of $3,000 less over time than someone who only looks at one mortgage quote.
Checking rates is great, but the problem arises when you apply for multiple mortgages.
How do you solve this problem?
Most credit scoring models treat all loan applications within a 30-45 day period as one credit extraction. Therefore, you should submit all applications within that time period to reduce the impact on your score.
However, some lenders use older FICO scoring models, so consider submitting your applications within 14 days.
The money you save by refinancing should offset any drop in your score. With lower monthly payments, your credit score should improve over time as you maintain a good payment history (which accounts for 35% of your FICO score) and use your savings to help reduce your overall debt (which accounts for 30%).
2. You close your existing mortgage account
According to mortgage data company Black Knight, about 19.3 million mortgage holders could refinance and reduce their interest rate by at least three-quarters of a percentage point (0.75), which would be enough to reduce their monthly payments by an average of $299.
But beware: if you refinance your home loan, close one account to open a new one. FICO takes into account the age of your oldest account and the average age of all accounts. This means that your score decrease in case you close a long-standing credit account. New debt – even if you’re still making payments on the same house – doesn’t have the same value to your credit score.
How do you remedy this?
As you pay off the new loan, your credit score should go back up – especially if your monthly payments are lower. If not, be patient and wait for your other credit accounts to age so that the impact of a refinance on your score diminishes.
In the meantime, use the savings from your new mortgage to pay off other debts. Not only will you reduce the amount you owe, but you will also reduce the percentage of your credit that you use, known as credit utilization. Reducing this percentage does wonder for your score.
Save even more money on debt by comparing home insurance prices each time your policy comes up for renewal. Your current coverage may be at a lower price.
3. You miss payments during your refinance
According to Equifax, when missing a payment on the original mortgage, some borrowers might get into trouble assuming their refinance has been granted.
Since payment history is the most important factor in determining your credit score, missed or late payments can lower your score.
They can reflect for seven years on your credit report
What can you do about it?
Don’t stop making payments on your old mortgage until you’re sure your refinance is complete.
Stay in constant communication with your lenders and don’t assume that the process will be completed by a certain date.
Other ways to improve your credit rating
You won’t be able to take advantage of the lowest mortgage rates if your credit score is below average. Here are four other ways to improve your score:
Let the experts monitor your score. You can get help for free to check and monitor your score. If you sign up for Credit Sesame, for example, you’ll get an overview of your credit score and free access to credit monitoring.
Consolidate your debt. Having trouble keeping up with monthly payments? Late payment is the main raison for your credit score going down faster. A debt consolidation loan allows you to take out a new low-interest loan and use it to pay off all your high-interest debts. With a free online service like Credible, you can get the best debt consolidation loan options.
Dispute errors in your reports. Get free copies of your credit reports and comb through them line by line to see if there is any outdated or incorrect information. These could be loans you’ve already paid off or debts that don’t even belong to you.
Add to your credit mix. Lenders like to see a healthy mix of credit, such as mortgages, auto loans, and credit cards. A secured credit card can help you build your credit history, especially if you can’t get approved for a real card. These cards have low limits and require a deposit; if you compare offers, you may find one with attractive terms, such as no annual fee and a minimum deposit amount that works for you.