What credit score is ideal for refinancing? The obvious answer is the best one you can achieve. That's because the higher your score, the lower your interest rate and monthly payments are likely to be.
But don't despair if your score is going through a rough patch. Some refinance programs are designed for people with poor credit. In fact, some allow you to refinance without your score being checked at all.
Understanding Credit Scores
Your Credit Report
Many people are confused about the difference between a credit score and a credit report. Well, a credit report is just an electronic file, maintained by a credit bureau, that contains a record of:
- All your accounts' details (including credit limits and balances, where applicable) and payments you've made or failed to make on time
- The applications you've made for new credit, whether or not an account was opened
- Any loans you've defaulted on
- Any financial black marks against you on the public record, such as liens, foreclosures, and bankruptcies
These records usually go back seven years, and entries should be scrubbed completely when they reach their seventh birthdays. There's an exception for bankruptcies, which can hang around for a decade.
By law, you're entitled to a free copy of your credit report once each year, and you can get yours from annualcreditreport.com
Your Credit Score
Your credit score is a three-digit number and is based entirely on the contents of your credit report – and nothing else. Credit scoring systems (the two biggest are FICO's and VantageScore's) are sophisticated computer algorithms that constantly monitor your credit report, assigning a value to each entry in order to calculate your score.
Those values are weighted by importance and recency. So something trivial, such as an application for new credit, will produce a very small hit to your score, which could have receded to nothing within just a few months. Something serious, like a bankruptcy, could seriously harm your score, and might still be affecting it many years later, though less and less severely as time goes by.
FICO explains the five things that affect your score using its systems (with the percentage impact of each in brackets):
- Payment history – Whether payments are on-time, late, skipped, or in collection, including information from public records (35 percent)
- Amounts owed – This is mostly about the proportion of your available credit you use, so keep card balances down below 30 percent of your credit limits (30 percent)
- Length of credit history – This is mainly based on the average age of all your accounts, so think twice before unnecessarily opening new ones or closing old ones (15 percent)
- New credit – New credit applications have a small impact, though, multiple applications within a focused period when you're shopping for a mortgage, refinance, or auto loan count as just one single event (10 percent)
- Credit mix – It's good to have a mix of revolving credit, such as credit cards, and non-revolving credit, which is an account with fixed payments and a firm end date, such as a mortgage, auto loan, personal loan, and so on (10 percent)
Why You Have Many Credit Scores
Anyone with a credit report is bound to have at least six credit scores. That's because there are those two, main credit scoring systems (FICO and VantageScore) and three major credit bureaus (Equifax, Experian and TransUnion), each of which is likely to have slightly different information and use its own slightly tweaked version of FICO's and VantageScore's systems.
Then there are lenders. Some use industry-specific versions of scoring systems. For example, an auto lender might use a version that has been adjusted to better assess its customers' creditworthiness, and a mortgage lender might have a different version that's been tweaked to meet its needs.
Meanwhile, like all software applications, there are various generations of FICO and VantageScore systems, each of which might produce a slightly different score from the same credit report. In addition, not all lenders upgrade at the same time. So if you apply to refinance with three lenders, each might have a different version of the same basic software, potentially leading to different scores.
All this means that you probably have dozens of different credit scores. But it doesn't mean you should shrug and move on. They are all influenced in similar ways by the same activities, so it is still a good idea to monitor "your" credit score. When that one goes up or down, all the others are likely to follow, though, possibly to a slightly greater or lesser extent.
Credit Scores and Refinance Rates
One thing's for sure: Your credit score can have a huge impact on the refinance rate you're likely to be offered. FICO has an online calculator that lets you see just how much impact scores have. We used it to provide an example for a $150,000, 30-year fixed-rate mortgage refinance, based on average rates nationwide on March 13, 2017. You should check today's mortgage rates to see how things have changed since then.
On that day, someone with a great score (760-850) might have expected to be offered a rate of 4.028 percent, while someone with a relatively poor one (620-639) would likely have been offered 5.617 percent. That translates into monthly payments of $719 for the more creditworthy borrower, compared with $863 for the person with a less good financial record. That's a difference of $144 a month!
But a 30-year mortgage lasts 360 months. And over that whole period the difference in the amounts the two borrowers would pay would be (Are you sitting down?) $51,840. When it comes to a refinance, credit scores count.
The Optimal Credit Score for Refinancing
Obviously, those two examples are based on borrowers with the highest and lowest scores within the range that homeowners are likely to be approved for a refinance. So, there's a good chance you'll be somewhere between those two extremes.
Credit Score Bands
Unless you're firmly within the top group, you should be aware that even a small upward movement in your score could save you serious money. That's because lenders often use score banding, and they'll treat everyone within a particular band the same. So suppose your score is 658. Your lender may treat everyone with scores in the band between 640 and 659 the same. But if you could get your score up by just two points, you would be in the 660-679 band, which might typically save you $39 a month, or $14,040 over 30 years, according to FICO.
Now lenders aren't obliged to use the same bands, and some may not use them at all. But, there are some that might use FICO's credit bands, which are:
Remember, each of your prospective lenders may see a slightly different credit score from the one you and the others see. So don't rest on your laurels, get your score up as far as you can.
How to Improve Your Credit
Ideally, you should check your credit report and score well before you apply for a refinance. That gives you a chance to gauge the task ahead and to work to improve your score. Here's what you need to do before you make that application:
- Make sure you pay every bill on time.
- Pay down as much credit-card and store-card debt as you can. You want to get your balances on every card (and across all your cards) down below 30 percent of your credit limits, though, the lower the better.
- Don't open or close any credit accounts.
How to Get Your Credit Score
You can get your credit score from many sources. You may even find it on your credit card or loan statements.
But you can also sign up for the LendingTree free credit score service. This lets you continuously monitor your score and receive updates on money-saving, financing opportunities. And it's 100 percent free!
Shop Around for the Best Refinance Deals
It doesn't matter how good or bad your refinance credit score is, you can often make savings – sometimes serious ones – by shopping around for the best deal.
Just about every financial journalist and relevant government agency would urge you to get quotes from multiple lenders before you commit to a refinance. Only then will you be able to compare rates and ensure you're getting the best refinance deal possible. And, as you saw with credit scores, even small differences in monthly payments add up over time.