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Does Refinancing a Car Hurt Your Credit?

November 3, 2021

If you’ve ever considered an auto loan refinance, you may wonder how it will affect your bigger financial picture. One question a lot of borrowers ask: Does refinancing a car loan hurt your credit?

Let’s dive into the details of this important financial decision, including how refinancing impacts your credit and how you can refinance a car with bad credit.

How Does Car Refinancing Work?

Refinancing your auto loan is fairly straightforward. After you check your personal loan eligibility and apply, the lender will review your application and check your credit. If approved, the lender will issue payment for the remaining loan amount to close out your existing loan.

Once the previous loan is paid off, the original lender will remove the lien from your car’s title, while the new lender will replace it with their lien. After the process is complete, you are responsible for paying down your newly-refinanced auto loan.

What Happens to Your Credit Score When You Refinance Your Car?

Refinancing a car will temporarily ding your credit score since the lender will perform a hard credit check—but it shouldn’t drastically hurt your score or damage it in the long term.

To understand how refinancing will affect your credit score, let’s look at how credit scores are calculated. Most major credit scoring models consider five types of information when calculating scores. For example, FICO uses these categories for its FICO score:

  • Payment history (35%)
  • Amounts owed (30%)
  • Length of credit history (15%)
  • New credit (10%)
  • Credit mix (10%)

When you apply for an auto loan, the lender pulls your credit information through a “hard pull.” Hard pulls, also called hard credit inquiries, are part of the new credit portion of your credit score. A hard pull will typically drop your credit score a few points, but the negative scoring impact should neutralize within two to three months.

Wondering how shopping around for the best rate could affect your score? If you apply for many different types of credit over a short period (for instance, car refinancing and credit cards), it could have a negative impact. “However, algorithms like FICO’s are set up to let you roll several inquiries into one if they’re for the same type of loan,” writes Abby Hayes at Dough Roller. The time allowed to shop around varies by scoring model, but the period usually ranges between 14 to 45 days.

Refinancing your auto loan closes your old car loan and adds a new car loan to your credit report. If the scoring model weighs closed accounts less than open accounts, the payment history portion of your credit score could be slightly affected since the payment history on the old loan may now carry less weight.

When you refinance your car, the balance on the old auto loan and new auto loan are equal, so the amount owed portion of your score shouldn’t change much.

The length-of-credit-history portion of your credit score may be impacted, but only slightly. Closing your old auto loan may decrease the length of your credit history and the average age of your accounts. Unless your auto loan is the only credit account or one of few accounts on your credit report, it likely will not make a big difference.

Finally, the credit mix portion of your credit score shouldn’t change much since you’re replacing one auto loan with another.

Benefits of Refinancing Your Car Loan

Refinancing can come with a couple of potential benefits. 

Save money on interest.

If you can get a better interest rate through refinancing, you can reduce the total amount of interest you spend over the life of the loan. 

Lower your monthly payments.

You may be able to reduce your monthly payment amount by lowering your interest rate or lengthening your loan term.

Pay off your loan sooner.

If you can handle a higher loan payment, you can try to refinance into a shorter-term loan, which means you’ll be done with debt sooner (and potentially save money on interest).

Use your car like an ATM.

If you’ve made a fair amount of payments and your car has held its value, you may be able to tap into its equity with a cash-out refinance. Essentially, refinancing for more than what you owe so you can take the rest in cash). 

When Refinancing Your Car Might Make Sense

1. You got the loan from the dealership.

If you got your loan from your car dealer, you may not have received the best rate possible. The dealership is typically an intermediary between the buyer and the auto lender, and they may mark up the interest rate to compensate for their involvement. You may be able to get a better rate by refinancing directly with an online lender, credit union, or other financial institution.

2. Your credit has improved.

If your credit score has increased since you first took out the loan, and you’ve been making on-time payments on your original loan for at least a few months, you may qualify for a lower interest rate through refinancing. 

3. Interest rates have gone down.

If prevailing interest rates have decreased since you first took out your loan, you may be able to take advantage of today’s lower rates. Looking at historical auto loan rates can help you determine if you’re in this camp.

4. You need a lower car payment.

Even if you’re unable to lower your interest rate rate, refinancing can still help you get a lower monthly payment. By refinancing into a loan with a longer term, you can make smaller payments over a longer period of time, which can free up cash for other monthly expenses. Just be aware that this strategy can result in a higher total interest cost over the life of the loan. 

When Refinancing a Car Might Not Make Sense

Refinancing can come with a number of benefits, but it’s not always the right move. What are some reasons you wouldn’t want to refinance?

1. Your loan is almost paid off.

If you don’t have much time left on your loan, lenders likely won’t want to refinance your loan. LendingClub, for example, requires at least 24 months left on the loan term to consider a refi.

2. Your loan is underwater.

Being upside-down or underwater on your auto loan means that the repayment amount on your loan is more than the car is worth. While it can be possible to refinance an underwater loan, it typically comes with high interest rates and unfavorable terms.

3. The prepayment penalty is too high.

Since the new lender is paying off your old loan early, you may be subject to prepayment penalties in the process. Check with your original lender to see what fees you may incur, then compare it with your potential savings to make sure it’s worth it.

How Can I Refinance a Car with Bad Credit?

While it’s ideal to refinance when your credit is in good shape, it may be possible to refinance a car loan even with bad credit. However, you’ll likely pay much higher interest rates if your credit is less than stellar. Instead, you might consider working to improve your credit score before you try to refi.

5 Ways to Improve Your Credit Score for Car Refinancing

1. Pay bills on time.

Payment history is a major factor in your credit score, so make it a point to pay your bills on their due date. If that’s not possible, do your best to make a payment within 30 days. 

2. Check your credit report.

You can’t fix what you don’t know is broken. Pull your free credit report, check for inaccuracies, and get them fixed if possible.

3. Lower credit utilization.

If you have a high amount of credit card debt compared to available credit, focus on paying that debt down.

4. Hold off on closing credit cards.

Closing accounts can temporarily ding your score since your available credit amount immediately goes down. If a refi application is in your near future, consider keeping cards open until after you’ve applied.

5. Consolidate your debt

While a debt consolidation loan can actually temporarily decrease your credit score, over the long term it could have a positive impact. It’s typically easier to make one fixed monthly payment vs. multiple payments toward high- and/or variable-interest debts.

The Bottom Line

So, is refinancing a car bad for your credit? It may drop your score a few points, but as long as you make your monthly payments on time, your score should recover quickly. More importantly, refinancing can save you money and/or lower your monthly payments.

Unless you’re planning to take out a large new loan in the very near future—for example, a mortgage—don’t let a short-term, small drop in your credit score keep you from refinancing your auto loan and saving money.

If you didn’t shop around for your current auto loan, your credit score has improved, or interest rates have decreased since you took out your initial car loan, check to see if you could get a lower interest rate by refinancing your auto loan.

Think you’re ready to refinance? Check out our tips for refinancing a car. Or, if you’re just starting the car-buying process and debating leasing vs. buying, check out our blog post on the important factors to consider.

Refinancing a Car FAQs

1. How many points does your credit drop when you refinance your car?

Refinancing a car may result in a temporary decrease to your credit score since the lender will perform a hard inquiry. However, it shouldn’t drastically hurt your score or damage it in the long term, especially if you make payments on time. 

2. How does refinancing a car lower your payment?

You may be able to reduce your monthly payment amount by lowering your interest rate and/or lengthening your loan term. By refinancing into a loan with a longer term, you can make smaller payments over a longer period of time. Just be aware that this strategy can result in a higher total interest cost over the life of the loan. 

3. How long should you wait to refinance a car?

Most lenders want to see that you’ve been making on-time payments on your original loan for at least a few months. LendingClub, for example, requires 90 days before you can apply to refinance your auto loan.

4. Is it bad to keep refinancing your car?

There’s no limit on how many times you can refinance your car. However, refinancing is subject to lender approval as well as potential charges, such as origination fees, so it may not be financially savvy to repeatedly refinance.

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