How Does Refinancing My Car Loan Affect My Credit?

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by Anna Baluch

Refinancing your car loan will affect your credit but that doesn’t mean you shouldn’t consider it.

If you wish your current auto loan was more affordable, refinancing may be a good option. It can allow you to replace your current loan with a new loan and save a lot of money on interest over time. Refinancing may also leave you with lower monthly payments and free up your monthly cash flow.

It may be a good option if your car is retaining value, interest rates are going down, or your credit score has increased. Refinancing may also make sense if you’re short on cash flow, want to add or remove a co-borrower, or are worried about repossession.

Before you take the plunge and decide to pursue this strategy, however, it’s important to consider how refinancing a car loan affects credit. After all, good credit is the key to landing the best interest rates and most favorable terms down the road. You don’t want to refinance and later find out that your credit score has taken a large, long-term hit.

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Does Refinancing an Auto Loan Hurt Credit?

In a perfect world, you’d refinance your car loan and keep your credit score where it is. The reality, however, is that refinancing can hurt your credit because lenders will assess your creditworthiness or how worthy you are to receive credit.

To do this, they’ll likely pull a hard inquiry, which may bring your credit score down by up to five points. Let’s dive deeper into how refinancing an auto loan may hurt your credit.

Hard Inquiry

When you decide to refinance your car loan, the bank, credit union, dealership, or other lender will want to know what kind of borrower you are. If you’re a responsible borrower, they’ll take on less risk when they lend you money. So they’re likely to offer you a lower interest rate and better terms.

On the contrary, if you have a track record of irresponsible financial behavior, their offer won’t be as attractive. You’ll pose a greater risk to them, and they’ll make you pay for it with a higher interest rate.

Multiple Loan Applications

To ensure you get the best rate and terms for refinancing, you’ll want to shop around and apply with different lenders. When you apply with too many lenders over the course of a year, however, your credit score will likely take a hit.

Fortunately, most credit scoring models will treat every application you make within 14 to 45 days as a single inquiry on your credit score. Whether you submit two or 20 applications in this rate shopping period, you won’t have to worry about a huge dip in your score. But if you apply to many loans over several months, you may notice a negative change on your credit.

Fortunately, most credit scoring models will treat every application you make within 14 to 45 days as a single inquiry on your credit score.

Closed Account

An auto loan refinance involves closing your original loan and replacing it with a new one. If you’ve had your original account for quite some time, you’ll lose the credit limit you had on it. This may increase your credit utilization ratio or the amount of credit you’re using divided by the total amount available to you. Ideally, you’ll want to keep your ratio to no more than 30% of your credit so closing your auto loan account can cause your score to suffer.

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How Long Will My Credit Score Be Affected?

Although hard inquiries will stay on your credit report for two years, they’ll usually only affect your credit score for the initial 12 months. You’ll notice that the negative impact of a hard inquiry will slowly but surely subside over time. Knowing that your credit score dip will only be a short term consequence should give you some peace of mind.

Should I Refinance My Car?

Now that you know refinancing your car loan has the potential to ding your credit, you may be wondering whether you should move forward with it. Refinancing your car loan is likely a good move if you can relate to one of these circumstances.

Your Car is Retaining Value

Before you go ahead and refinance your car loan, figure out your car’s resale value. Sources like Edmunds.com, Kelley Blue Book, and the National Association of Auto Dealers (NADA) can give you an idea of whether your car is retaining its value or upside down. If you find that you owe more on your car than it’s worth, it’s in your best interest to stay clear of refinancing.

Interest Rates are Going Down

If interest rates are dropping, you may be eligible for a lower interest rate than you were able to secure with your original car loan. In March 2020, the Federal Reserve cut rates in response to the coronavirus pandemic. So now may be a great time to refinance your car loan and save some more of your hard-earned cash.

Your Credit Score Has Increased

Your credit score may have been lower when you took out your original car loan than what it is today. If you’ve earned a substantially higher credit score in the year or so after you took out your car loan, you may want refinance. Chances are you’ll be able to lock down a car loan with a much better interest rate.

You Need Extra Cash

Maybe you’re growing your family. Or perhaps you’d like to allocate more money toward your retirement. Whatever your situation may be, auto loan refinancing can give you the chance to lower your monthly expenses. With lower expenses, you’ll find it easier to meet your short and long-term financial goals.

You Want to Remove or Add a Co-Borrower

To remove or add a co-borrower from your car loan, you’ll need to refinance it under the name of the person you’d like on the loan. You may have a co-borrower if you were unable to get approved for a car loan on your own.

If this holds true and you’ve built up or improved your credit history, it may be time to remove your co-borrower through refinancing.

You’re Worried About Repossession

If you’re falling behind on car payments, your lender may repossess or take back your vehicle. To reduce the risk of this, you may want to refinance. You can apply for a longer loan term and get a lower monthly payment you can afford. Refinancing can mean the difference between keeping your car and having your lender take it away.

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Ways to Reduce the Impact on Credit 

If you choose to refinance your car loan, rest assured there are some things you can do to reduce its effect on your credit including:

Understand Your Credit Score

Before you begin the process of refinancing your car loan, you should know where you stand credit wise. Since checking your credit reports won’t take a toll on your credit, it’s wise to do so. You can get a copy from them for free once a year on AnnualCreditReport.com.

Once you know what your credit is like, you’ll have a better idea of the types of lenders that may approve you. With access to your credit reports, you’ll also be able to check for any errors that may hinder your ability to get approved for a loan. If you notice any inaccuracies, make sure to dispute them before you apply for refinancing.

Shop for Refinancing Loans at Once

Remember that most credit score models will treat all your applications within a 14- to 45-day period as one inquiry. If you adhere to this timeline and only apply for refinancing during it, you can significantly reduce the impact of refinancing on your credit.

Pre-qualify

When you pre-qualify for car loan refinancing, you’ll find out what type of rate and terms a lender may offer you. Pre-qualifying is ideal because it involves a soft inquiry rather than a hard inquiry. Fortunately, a soft inquiry won’t affect your credit score at all.

What to Do After Auto Loan Refinancing

Once you’ve refinanced your car loan and accepted a temporary decline to your credit score, prove that you’re a responsible borrower by establishing a good payment history. Fortunately, it only takes six months to do so. So you won’t have to wait forever to see results.

To build a strong payment history, make your car payments on time. Don’t forget that even one missed payment can hurt your credit. If you’re worried you’ll forget a monthly payment, enroll in automatic payments with your lender or set up reminders in your calendar. Work hard to make your car loan payments on time and your credit score is likely to go back to where it was before you refinanced. Believe it or not, it may even improve!

Note that while your auto refinance will stay on your credit report for two years, it’ll only affect your score for the first 12 months. Therefore, you may want to wait at least a year before you apply for a mortgage or another type of loan. By waiting, you can increase your chances of landing a lower interest rate.

Refinancing May Be Worth It 

Fortunately, refinancing a car loan is easy and straightforward. As long as you’re okay with a small, short-term hit to your credit score, this strategy can improve your finances. It may save you money on interest and/or lower your monthly payments.

Unless you’re not in a situation where it makes sense, don’t allow a temporary credit drop to keep you from refinancing and putting hundreds or even thousands of extra dollars in your pocket. It can be an effective way to improve your financial situation.

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