Does refinancing a car hurt your credit?
Key takeaways
- Refinancing may temporarily lower your credit score by a few points.
- Applying for any loan or credit product generates a hard inquiry, but many lenders offer prequalification to check your rates first.
- Refinancing could be worth it if the average market rate is lower or your credit score has improved since you took out your current auto loan.
Refinancing a car loan means your credit will take a temporary drop. When you take out any new loan — including when you refinance an auto loan — the lender typically does a hard credit check. This can mean your credit score drops a few points, although other factors will play into whether you see an actual change in your score.
Don’t steer clear of auto refinancing just because of a temporarily lowered score. If you can secure a better auto loan rate, it could be a sound decision that results in cost savings or much-needed financial relief.
How does refinancing an auto loan affect your credit?
A lender will need to do a hard inquiry to confirm you qualify, which is the primary reason you will see it fluctuate. This is why refinancing a car loan can lower your credit score temporarily, but regular, on-time payments should quickly offset the damage.
It can also decrease the average age of your accounts and act as a new account on your profile. Essentially, refinancing restarts your car loan. That can make it harder to qualify for other types of credit in the short term.
It generates hard inquiries
Each time you apply for a loan, a hard credit inquiry is generated. This could result in a slight dip in your credit score. Hard inquiries remain on your credit report for up to two years but only impact your score for up to 12 months. Consequently, refinancing a car loan — which involves applying for a new loan — could temporarily ding your credit score, especially if you apply with multiple lenders.
If you submit loan applications within a 14-day period, the FICO credit scoring model will group them into a single inquiry. If the lender uses VantageScore, this window lasts up to 45 days. This is considered rate shopping, and it can minimize the impact on your credit score.
A hard inquiry from a lender can drop your credit score by up to five points. Your score may be less impacted if you have a good or excellent credit rating.
It lowers your accounts’ average age
Refinancing also lowers your average age of accounts, leading to a possible decrease in your credit score. The good news is account age only counts for 15 percent of your credit score under the FICO model.
Depending on your credit profile, this may not impact your score very much. Your payment history and total amount of debt account for 35% and 30% of your credit score, respectively. For many, this could potentially offset the drop when you refinance an auto loan. If you have older accounts in good standing or carry very little debt, you should see minimal impact on your credit score.
It may be reported as a new loan
If your loan refinance is reported as a new loan, it will more significantly impact your credit profile. Refinancing will not only generate a credit inquiry, but it may also have the added impact of creating a new “open date” on your profile. When a new open date shows up, it tells the credit agencies you have taken on a new debt obligation, increasing your overall debt load.
Carrying some debt can be a good thing, but lenders worry if you take on too much. You can determine if you have a healthy amount of debt by calculating your debt-to-income (DTI) ratio. DTI is a measure of how much of your monthly income goes toward debt payments. A DTI under 36 percent is considered very good, while you may struggle with approval if you have a DTI of 42 percent or higher.
You can keep your DTI lower when you refinance your auto loan by choosing a loan with a lower average rate or monthly payment. Another option is to pay down other debt before applying to refinance.
How long will your credit score be affected by refinancing?
Even though refinancing a car loan impacts your credit score, these effects are only temporary. Within a few months of uninterrupted, on-time payments, your credit score should return to where it was before you refinanced. In some cases, it may even increase slightly. If you have any hard inquiries related to your refinancing, these score impacts will fall off entirely within a year.
One of the main benefits of refinancing is lowering your monthly payment. If you are able to secure a monthly payment that fits within your budget and helps you pay down more expensive debts, your financial position will likely improve. While there will be some short-term negative impacts when you refinance, your credit score should improve over time if you keep up with regular payments.
How to limit harm to your credit score
Refinancing may lower your credit score. Assess whether it’s the right time to refinance and consider ways to minimize the impact on your credit score.
- Get prequalified: Shop around to find the best deal on refinancing. Once you have a shortlist of preferred lenders, apply for prequalification to view potential financing offers without affecting your credit score.
- Pay on time each month: The most significant component of your credit score is your payment history. It accounts for 35 percent under the FICO model, so paying your loan on time each month will help your credit score bounce back.
- Wait to open additional credit accounts: Your credit age will decrease when you refinance. Holding off on opening new credit accounts after refinancing will help improve this number and possibly raise your credit score over time.
- Consider Experian Boost: This optional program means you can help boost your credit score by including payments on day-to-day bills like streaming services, rent and utilities. Experian Boost participants have a reported 13 points added to their FICO 8 credit score.
Is refinancing a car worth it?
Refinancing an auto loan can be worth it for some, but the cost may outweigh the benefits for others. To get the most use out of refinancing your auto loan, you will need to qualify for a lower average rate or monthly payment — or both.
Refinancing could be worthwhile if
- Average auto loan rates have dropped recently.
- You have improved your credit score since taking out your original auto loan.
- You need to extend your term to lower your monthly payments.
Refinancing is likely not a good idea if
- You are close to paying off your auto loan.
- You will face prepayment fees.
- You have an older vehicle.
- Lowering your monthly payments will leave you upside-down on your auto loan.
Bottom line
The choice to refinance your car loan has benefits and drawbacks. Although it can temporarily hurt your credit score, the financial benefits may significantly outweigh the damage. There are also ways to minimize the impact on your credit score and help it rebound when you apply for refinancing.
Before deciding if refinancing makes sense, familiarize yourself with the process to avoid surprises. Also, explore auto loan refinance rates, get prequalified and run the numbers to make an informed decision.
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