Auto refinancing is a great way to save money on auto loan payments. But is it worth it and will refinancing a car hurt your credit score?
Whether you like it or not, car ownership is an absolute necessity for the average American. Nothing beats the convenience of driving around in your own vehicle – as long as you can afford it! Unfortunately, auto loans have become exceedingly expensive to service, with Experian reporting that average loan amounts have risen by $2000. In such situations, auto refinancing seems like a logical thing to do to save money.
However, we understand the stress you feel when applying for refinancing. We’re 100% sure that the question “Does refinancing a car hurt my credit?” will be running through your mind – especially if you’ve carefully built up your credit score over the years!
TL;DR: Your precious credit score drop may drop a few points when applying for auto refinance. But that’s not necessarily a bad thing! Let’s find out why.
How does refinancing a car loan affect your credit score?
When you apply for new credit, and a hard inquiry is made on your credit report, this credit scoring model may lower your score by a few points. A new account also decreases the average age of your credit accounts, affecting your overall FICO score. Here’s a closer look at what happens to your credit when you refinance a car loan:
It makes hard inquiries. Every time you apply for a loan, a hard inquiry is made on your credit, which could cause your credit score to drop a little. Hard inquiries stay on your credit report for up to two years, but they only affect your score for up to a year. Since refinancing a car loan means applying for a new loan, it could hurt your credit score for a short time.
It lowers the average age of your accounts. Refinancing also lowers the average age of your accounts, which could cause your credit score to go down. Account age only makes up 15% of your credit score, which is good news. Your score should go up quickly if you take care of your new auto loan and other debts in a responsible way.
It has a bigger effect if it’s reported as a new loan. If your loan refinance is reported as a “new” loan, it will have a bigger effect on your credit score. The refinance will not only result in a credit inquiry, but it will also give your profile a new “open date.” When a new open date shows up, it tells the credit agencies that you have taken on a new debt obligation, which increases your overall debt load.
How does refinancing a car loan affect your credit score?
Credit scores are an important part of determining whether or not you are eligible for auto refinancing. Companies like FICO and VantageScore maintain individual credit scores on citizens to determine their creditworthiness. A high credit score will get you a low interest rate and vice versa.
Usually, a hard credit inquiry is initiated when you apply for refinancing, which can negatively impact your credit score by a few points. However, the drop is only temporary, it will increase in the following months as long as you keep up with the monthly payments.
- The impact on your credit will be minimal if you have already built up a high credit score and have a good credit history.
- If you’re consistent, your score in the following months could even rise higher than what it was before your refinance application.
How can you reduce the impact of auto refinancing on your credit?
If you’re someone who’s struggled with maintaining a decent credit score and don’t want multiple hard inquiries to tarnish it at once, you can always shop around for rates with lenders that offer a pre-qualification process.
- Pre-qualification or pre-approval for auto refinancing involves a soft credit check which will not affect your credit score. Based on the soft credit inquiry, you will be shown a list of offers that you have been pre-approved for. However, this is only a way to compare the rates and benefits offered by each deal. Once you finalize an offer, you will still have to go through a hard credit inquiry which will affect your credit score. There could be some difference in the terms offered in the final offer as well.
- If you’re hell-bent on reaching out to multiple lenders for final offers, be ready for several hard inquiries. However, an advantage of this is that if you undergo several inquiries in a short period, most credit agencies will bundle them and treat them as a single inquiry. VantageScore has a 14-day window for hard inquiries of the same loan type, while FICO has a 45-day window.
You can also minimize the impact of car refinancing on your credit by improving your score in the months leading up to your application. You can do this by:
- Checking your credit reports regularly and tracking any risk factors
- Being on time with your current payments
- Clear any pending dues, past-due accounts, and other fees
- Applying for credit only when you need it
Also read: Can you refinance a loan with bad credit?
Is there a downside to refinancing a car?
Often, refinancing a car can give short-term benefits like lower monthly payments, but you may lose money in the long run unless you’re careful. For example, each lender charges titles fees, origination fees, and other processing fees during your refinancing process. These may add up to more than the savings from refinancing.
Another situation in which you may lose money is if you are upside-down on your current loan – where you owe more than what the car is worth. This is often the case when you choose extra-long terms like 72 or 84-month terms. The interest incurred in paying adds to the monthly payments and you may end up paying more in the long run.
How much will my score go down if I refinance my car?
Even though the hard credit checks done as part of your application to refinance your car will stay on your credit report for two years, most credit scoring models only look at inquiries made in the last year. Most of the time, credit checks won’t change your credit score by more than 5 points. But remember that a credit check will hurt your score more if you have a short credit history or few accounts.
If your credit score is above 750, which is also called the “super-prime credit tier,” a temporary hit to your credit won’t hurt you very much. Lenders see you as a borrower with less risk, so they give you the best rates.
How does car refinancing work?
Auto loan refinancing means taking out a new loan to pay off the remaining portion of your current auto loan. The new, refinanced loan will have better terms and conditions – like lower interest rates, lower monthly payments, or a longer loan term. When your new loan is approved, the refinance lender will pay your previous lender the payoff amount.and transfer the lien (right to possess the vehicle in case of default) to itself. If done right, auto loan refinancing can help you save hundreds of dollars over the course of the loan.
You can choose to refinance your auto loan when your credit score has improved or if you want to lower your monthly payments to keep your expenses in check.
When is the best time to apply for car loan refinancing?
There are a few common situations when you can refinance your car and save money.
- When you want to change your current deal: If you financed your existing loan from the dealer, it’s possible you’re paying more than required as a monthly payment.
- If your credit score has risen: You can get better APRs for car refinancing if your score has improved in the past year.
- If you want to change the loan term: A rise in monthly expenses may necessitate refinancing to reduce monthly payments.
- When interest rates are low: You can refinance auto loans to take advantage of low consumer loan rates in the market.
- If you want cash in hand: You can choose cash-out refinancing if you need ready cash to meet immediate expenses. This is only possible if you have positive vehicle equity (when resale value is more than what you owe on it).
Bottomline
The short answer is yes – refinancing a car can hurt your credit temporarily. However, you can easily bounce back and build your credit by staying on track with your monthly payments and keeping an eye on your other dues.
FAQs on refinancing a car
By how many points does your credit drop when you refinance your car?
According to FICO, your credit score can drop by a maximum of five points when you apply for refinancing. However, if you already have a good credit score and have built up a good history of payments, the drop will be less. The credit drop is temporary – as soon as you start repaying the loan on time, your credit score will improve. If you’re wary about a hard credit inquiry, some lenders also offer pre-approval through a soft credit check.
How long should you wait to refinance a car?
There is no minimum time limit that needs to lapse before you decide to refinance. However, it is good to wait at least six months before refinancing the loan. Your credit score will still be recovering after your recent application, and it’s important to build a good payment history before applying again.
Is it bad to keep refinancing your car?
Legally, there is no limit to the number of times you can refinance your car. However, every time you apply for refinancing, you have to meet the lender’s eligibility criteria – like minimum payoff amount, loan terms, minimum credit score, and vehicle equity. It’s highly unlikely that you will be able to meet all of their criteria. Additionally, borrowers who refinance their auto loan multiple times can be seen as financially irresponsible and rejected. Therefore, we would advise you not to refinance your car more than two times.
When is it a good idea to refinance a car loan?
If the interest rate you can get on a new loan is much lower than the rate on your old loan, it may be a good time to refinance your car loan. If it stays the same or goes up, you probably shouldn’t refinance.
How long should you wait to refinance a car?
While legally you could refinance your automobile as soon as you purchase it, you should wait at least six months to a year to give your credit score time to recover after taking out the initial car loan, establish a payment history, and recover from any depreciation that occurred when you acquired.
How many points does refinancing affect credit?
Suppose you compare prices with four lenders over an extended period of time and each hard inquiry lowers your score by approximately 5 points. In that case, your credit score will decline by approximately 20 points.
What are the cons of refinancing a car?
When you refinance an auto loan, you might have to pay lender fees and more interest if you extend the loan term or take cash from your car’s equity. You could also end up owing more on your car than it is worth.
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