Refinancing can temporarily impact your credit, but potential benefits outweigh the cons.
If you’re hoping to lower your car loan payment, you’re probably considering refinancing. And why not? On average, borrowers saved about $97 per month after refinancing their auto loans last year. That’s more than $1,100 per year.
Before you get too excited thinking about how you’ll spend that extra cash, there are a few things to consider before hitting that apply button — like how much auto loan refinancing can help or hurt your chances of qualifying for other credit down the road.
From application to funding, here’s what you should know about auto loan refinancing and your credit score.
How Lenders Evaluate Auto Loan Refinance Applications
Fortunately, getting pre-qualified for auto loan refinancing does not impact your credit. It only requires a soft credit pull, or soft credit inquiry, so it won’t ding your credit score. This is a great first step for anyone who is interested in refinancing but wants to get an idea of the types of offers that may be available to them.
Once you complete and submit your application, lenders will assess your creditworthiness. Generally, they’ll look at the following to make a decision:
- Your car: Auto loans are secured which means your vehicle needs to meet the lender’s requirements to serve as collateral for the loan.
- Your loan: Borrowers with a loan-to-value ratio less than 125% to 135%, will likely qualify for more favorable terms. However, a solid payment history can help too.
- Your finances: Ideally, you’d have a steady income, a history of responsible borrowing behavior, and a debt-to-income ratio of 50% or lower.
If you don’t quite fit all of the criteria above, don’t sweat it. Every financial institution is different, and there could still be a lender willing to work with your credit profile, even if you have a lower credit score.
How Does Refinancing a Car Loan Affect Your Credit?
During the auto refinance process, you may notice credit activity during the application and funding phases. Most of the time, car loan refinancing only has a temporary impact on your credit score.
Hard credit inquiries
In order to evaluate your auto refinance loan application, you will need to consent to a hard credit check. A hard credit inquiry, or hard pull, can lower your credit score by around 5 points.
Credit inquiries make up about 10% of your credit score. If your credit history is strong or you have no intentions of applying for more credit in the near future, one inquiry might not make much of a difference. But, if your credit is already not so great, an additional hard inquiry could result in a less competitive rate for a large purchase like a mortgage — or possibly keep you from qualifying for one altogether.
Each credit inquiry stays on your report for two years. Too many hard inquiries could indicate the borrower is in financial trouble.
However, you won’t be penalized for rate shopping if you’re applying for auto loan refinancing with multiple lenders within the rate-shopping period. Those hard credit inquiries will count as one, though you’ll still see them on your report.
Auto loan refinancing involves closing your original loan and replacing it with a new one. But a longer credit history can boost your credit score.
Credit scoring models take into account the age of your loans, credit cards, and other types of debt. If your credit history isn’t very long, closing your current auto loan could lower the average age of your accounts which may cause your score to dip temporarily. Eventually, your new (refinance) loan will appear as a new account on your credit report.
Multiple loan applications
Applying for multiple types of loans at once — such as an auto loan refinance, as well as a mortgage or personal loan —will count as separate inquiries, even if you apply during the same time frame. Applying for multiple loan products means you’re probably opening different credit accounts over an extended period, which portrays a greater credit risk, as opposed to rate shopping for a single loan product.
How Much Will Refinancing My Car Drop My Credit?
Although the hard credit checks associated with your auto refinance application will remain on your credit report for two years, most credit scoring models only consider inquiries made within the past 12 months. Generally, the impact of credit checks on your credit score is minimal — around 5 points. But remember, a credit check will weigh heavier on your score if your credit history is short or you own fewer accounts.
If your score is above 750, also known as the super-prime credit tier, a temporary negative impact on your credit won’t affect you very much. Lenders view you as a lower-risk borrower, which lets you qualify for the best rates.
When Should I Refinance My Auto Loan?
Sure, refinancing your auto loan may inflict a temporary ding on your credit score but the overall benefits might be worth it. While the right timing depends on your financial situation, you should consider a refinance if you relate to any of these circumstances.
Market interest rates are falling
You may want to consider a refinance if the prevailing market interest rates have fallen lower than the rate on your existing loan. Keep an eye on current auto refinance rates and you stand the chance of qualifying for a new loan at a lower rate.
A drop in rates of as little as 2 to 3% could save you a lot in interest payments over the remaining life of your loan. Lower auto loan rates can reduce the overall interest you pay, or you could also spread monthly payments out over a longer term.
Your car’s worth more than you owe
If you’re not upside down, meaning you’ve paid down your loan amount and your total amount of debt is less than your car’s value, you have positive equity you can use to refinance. Checking your car’s resale value from Kelley Blue Book or Edmunds.com will help you determine how much you can sell your car for and negotiate better terms with a lender. The difference between your car’s value and your new loan could also put more cash in your pocket to cover expenses.
Car (LTV) Loan-to-Value Calculator
A loan-to-value ratio over 100% means you owe more on your loan than your vehicle is worth. An LTV over 125% can make it harder, but not impossible, to qualify for a refinance loan.
If your LTV is less than 100%, your car's value is higher than what you owe on your loan. The lower your LTV, the better.
Your credit score has improved
If your credit score has increased significantly since your last auto loan application, a refinance may help you lock in better rates and terms on your new loan. Good credit will also help you get a lower monthly payment on your new auto loan.
You are looking to add or remove a cosigner
Wanting to remove a cosigner from your auto loan may justify the need to refinance your current loan. You can apply for new credit to make yourself a single borrower. Similarly, a refinance can help you add a co-borrower to share the responsibility for your loan and use your combined credit to potentially lock in a lower interest rate.
Switching lending providers
If you’re unhappy with your current lender, say your credit union’s customer service isn’t as you like it, refinancing with a new loan may help you switch allegiance to a new lender and potentially save money on better loan terms.
You might even be able to refinance with your current lender and negotiate better terms if you have a good relationship and a history of on-time payments.
How To Refinance My Car Loan
If refinancing your car loan seems like the right financial decision, taking the right steps will help reduce the impact it can have on your credit score. Here’s how to go about the refinance journey.
When it comes to refinancing your car loan, rate shopping helps you compare different offers and pick better interest rates and loan terms. But there’s a catch; this could bruise your credit if you don’t do it within the required timeframe.
You can reduce the negative impact of any hard credit checks by completing all your applications within a set time frame. Depending on the credit scoring model (such as your VantageScore or FICO score), multiple hard inquiries made within 14 and 45 days are treated as a single inquiry. This means that limiting your applications to this window will have a minimal negative impact on your credit score. You can check with lenders on which credit scoring model they use before applying to be sure.
Review your credit
Your credit score is calculated based on information already available on your credit file, so you want to know your status beforehand. Getting your credit reports and reading through them could also help you point out and dispute errors that could be hurting your scores. You’re entitled to a free copy of your credit report every 12 months from the three major credit bureaus, Experian, Equifax, and TransUnion.
Checking your credit score also helps you understand what category your borrower risk profile falls into, usually super-prime, prime, near-prime, subprime, and deep subprime. The higher the tier of your credit score, the better your odds of qualifying for the best terms. If your score is close to a cusp, avoid any unnecessary credit inquiries that could drop your score into a lower tier.
Get pre-qualified for an auto loan
Pre-qualifying is a rather low-risk way of assessing loan options you could get. It only requires a soft credit pull, so you can expect to receive ballpark estimates of potential interest rates without taking a hit on your credit score.
Remember, these rates are not guaranteed and are just as accurate as the limited information available. It’s possible that once you apply your actual offers might have higher interest rates than what you pre-qualified for.
Refinance Benefits Outweigh Temporary Credit Score Ding
An auto loan refinance isn’t bad for your credit after all. While your score could drop a few points temporarily, you could enjoy lower car payments while taking advantage of falling market rates. Remember to do your rate shopping within the right time frame to avoid additional hard credit checks.
Don’t let a temporary, small hit on your credit score scare you from refinancing your car loan. Rate shopping, reviewing your credit, and getting prequalified can minimize any negative impact refinancing might have on your credit score.
About The Author
Caitlin is a former finance executive and contributor with more than 10 years of experience delivering impactful content and messaging solutions to support midmarket and Fortune 1000 companies. She has written hundreds of articles covering personal finance, insurance, investing, mortgages, and the automotive industry for publications like The Balance, GreedyRates, MoneyWizard, and more.