If you’ve ever considered refinancing your auto loan, you may wonder how it will affect your bigger financial picture. One question a lot of borrowers ask: Does refinancing a car hurt your credit?
Let’s dive into the details of how refinancing impacts your credit, and how you can refinance a car with bad credit.
There are several reasons to consider refinancing your car, from saving money on interest to lowering monthly payments. The former is a common scenario, given that many people get their auto loan from the car dealership where they buy the car—which is not usually the best interest rate.
When financing at a dealership, dealers ask lenders to quote rates—called buy rates—at which point they’ll lend money so you can buy your dream car. However, the actual rate you get on your loan may be different. The Consumer Financial Protection Bureau writes, “The interest rate that you negotiate with the dealer may be higher than the buy rate because it may include an amount that compensates the dealer for handling the financing.”
If you didn’t get the best interest rate initially, you may want to refinance your auto loan. “Just like refinancing your home can help you save money on interest and lower your monthly payment, the same situation may apply to your car,” writes Holly Johnson at The Simple Dollar.
Refinancing your auto loan is fairly straightforward. After you apply, the lender will review your application and check your credit. If approved, the lender will issue payment to pay off your old auto loan.
Once the previous loan is paid off, the old lender will remove the lien from your car’s title, then 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.
While refinancing a car probably won’t increase your credit score, it shouldn’t drastically hurt your credit score either. Most major credit scoring models consider five types of information when calculating scores. For example, FICO uses these categories:
When you apply for an auto loan, the lender pulls your credit information through a “hard pull.” Hard pulls, also called 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, 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 amounts 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.
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.
Start by making all of your credit account payments on time for at least six months to a year to prove you’re working towards better credit management. Lenders looking to refinance your car may be especially interested in how you make your current auto loan payments.
Once your credit is in the best shape possible, apply to refinance your auto loan. If denied, wait a few months before reapplying so you don’t lower your credit score with unnecessary inquiries.
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 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.
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