Refinancing won't do lasting credit score damage
By Jeremy M. Simon | Published: July 27, 2010
Credit Score Report
Dear Credit Score Report,
I recently refinanced three rental properties with one lender (all at one time). My credit score was 809, 802 and 820 with the three credit bureaus. As part of the package, Wells Fargo issued a Visa -- with a $15,000 limit -- though I did not want it and have not used it. Do you think refinancing three properties would have hurt my scores? -- Jai
Refinancing your rental properties and taking on new debt may cause your credit scores to fall somewhat, although any damage is likely to be quickly erased by responsible borrowing.
Refinancing usually involves paying off existing mortgages and replacing them with new loans. Although paying off a loan is viewed favorably by credit scoring models, any increase to your scores would probably be more than offset in the short term by taking on the new loans, which tends to lower scores. That scoring change can be confirmed by checking your credit. But FICO, creator of the leading scoring model that bears its name, says you shouldn't worry. "The good news is that any lost points due to refinancing can usually be regained within a relatively short time by keeping all payments current and credit card balances low, while taking on additional debt only as needed," says Barry Paperno, FICO's consumer operations manager.
Credit bureau Experian agrees that any damage is likely to be short-lived. "His credit scores should rebound very quickly because it will become clear that payments are being made on time and no additional new debt was actually taken on," says Rod Griffin, Experian's director of public education. Also, the benefits of the refinancing -- ideally, a substantial savings over the life of the mortgage loan -- should be worth taking a short-term credit score hit.
However, while lowering mortgage debt should help your wallet, it doesn't improve your credit score as dramatically as slashing credit card debt does. "While any account with a history of on-time payments and no outstanding balance tends to be treated positively by the FICO scoring formula, paying off a mortgage, auto loan or other installment-type loan is not typically as beneficial to a person's score as paying off a high balance credit card," Paperno explains. The reason, he says, is that while FICO has found that a high utilization ratio -- the comparison of debt to credit limits -- on revolving accounts is a strong indicator of a risky borrower, installment utilization isn't as predictive of a borrower who may fail to make future payments. "As a result, paying off a mortgage does not substantially lower the level of risk, so any increase in the score after paying off a mortgage would be very minimal, if anything," Paperno says.
But again, in refinancing a property, you aren't actually eliminating the debt, just shifting it to get more favorable terms and ultimately save money. "In this instance, the original loans were paid in full, but he didn't reduce his debt load because he refinanced the loans into a new loan," Griffin says. "The new loan may offset the positive impact of paying off the original debts."
If you agreed to the offer from Wells Fargo, that Visa card represents another new loan that could cause a brief dip in your credit score. "However, the addition of $15,000 of available revolving credit could, at the same time, serve to lower his revolving credit utilization ratio, as long as he has not increased the amount owed on his other credit cards," Paperno says. As mentioned earlier, a lower revolving utilization ratio is good for credit scores, so be sure to make regular small purchases with that plastic and then pay them off. Still, even FICO can't say for sure what the new account with its sizable line of credit will do to your score. "The net result of these two impacts on his FICO score is impossible to predict, though, as it also depends on other aspects of his credit report, such as how much he currently owes, how long he's been using credit and his overall record of on-time payments," Paperno says.
Therefore, if you need a concrete answer about how all your new debt has impacted your credit score, you'll need to do your own "before and after" comparison: Order your FICO scores from credit bureaus Equifax and TransUnion (Experian doesn't offer FICO scores for purchase) at myFICO.com for $15.95 each -- or you can try and track down your FICO for free. Only then will you know for certain how the combination of refinancing three mortgages and adding a new credit card has impacted your credit scores.
See related: How to make sure your credit score is a FICO score, Think twice before rolling credit card debt into mortgage refinancing, When refinancing, closing credit card accounts can cost you, Taking on more credit won't hurt a good credit score, Free FICO scores exist, but aren't easy to come by, Credit Score Estimator
Meet CreditCards.com's reader Q&A expertsDoes a personal finance problem have you worried? Monday through Saturday, CreditCards.com's Q&A experts answer questions from readers. Ask a question, or click on any expert to see their previous answers.
Three most recent Credit Score Report stories: