Refinancing your car loan can be a great way to get a better interest rate or a different loan term. But does refinancing hurt your credit?
We’ll explain how refinancing can affect your credit score and whether refinancing is a good idea.
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Will Refinancing Your Car Hurt Your Credit Score?
The short answer is yes—refinancing can negatively affect your credit score.
When you refinance a car loan, you must submit a new loan application, which results in a difficult credit check. The good news is that an inquiry does not stay on your credit report for long.
Another reason why refinancing may have a negative effect on your credit is that it shortens the life of your loan. One of the factors that contribute to your credit is the average length of your credit history. Once you pay off your current loan, the average age of your credit can drop.
In general, the impact of refinancing on your FICO score should be minimal. However, completing a credit check after refinancing is still a good idea to make sure it doesn’t affect your score too much.
How Does Car Loan Refinancing Work?
Refinancing a car loan is the process of replacing your current car loan with a new one. Most borrowers refinance to get a lower interest rate, a lower monthly payment or a different repayment period.
To refinance, you must submit a new car loan application, as you did with your original loan. If approved, you can compare the interest rate on the new loan with the rate you are currently paying. If the interest rate is lower, refinancing will help you pay less each month to borrow money.
When Should You Refinance a Car?
Since car refinancing can temporarily affect your credit score, you should first consider whether it’s the right financial move. Refinancing a car loan may be a good decision for you if you meet any of the following criteria:
- Interest rates have decreased: If average interest rates has decreased since you took out your original loan, it may be worth refinancing.
- Your credit score has improved: Making payments on time for a long period of time can improve your credit score. If your credit score has improved significantly since your original loan, you can save money by refinancing.
- Your car has good resale value: If your car is worth more than your car loan, refinancing can also help you save. Lenders may be more willing to offer you a better interest rate if you the car retains its value.
- Your loan is too expensive: Lower interest rates can give you significant savings each month, which may be important if your original car loan was too expensive. Refinancing your car loan may be one of the best financial decisions if it keeps more money in your wallet.
- You have a co-signer: A co-signer with good credit and a good payment history can also help you qualify for a better rate. A trusted friend or family member who is willing to co-sign on your car loan can help you save money.
- You need cash: If you have positive equity in your vehicle, you may also qualify for a cash-out auto refinance. This type of auto loan refinance replaces your existing loan and pays off the balance in cash.
Things to Consider Before Refinancing a Car Loan
Refinancing can be a great solution for some vehicle owners, but it’s not the best option for everyone. Here are some things you should consider before you refinance your car loan:
- Your credit score has decreased since your last car loan: If your credit score has dropped since your original loan application, chances are you won’t qualify for a better interest rate. In this case, it may be better to wait until you improve your credit or find a co-signer to refinance.
- Your loan provider charges a prepayment penalty: Some car lenders charge a prepayment penalty if you pay off your loan early. Additionally, you may need to make another down payment or pay an origination fee on the new loan. You need to calculate these additional costs to decide if the savings are worth it.
- The value of your vehicle is less than what you owe: You may find it difficult to refinance a car loan if you have negative equity in your vehicle. If you find a lender to approve you, expect to pay a higher monthly payment.
- Your car is almost empty: It may not be worth it to refinance your car loan if you have paid off most of the balance. Most of the interest you pay on a car loan is at the beginning of the term. In this case, you can pay more by replacing your current loan with a new one.
How to Minimize the Negative Impact on Your Credit Score
Even if you have an excellent credit score, refinancing may have a negative impact on your credit for a short period of time. While it’s not entirely avoidable, there are some ways you can minimize the effects, including:
Compare Rates in the Same Time Period
Comparing interest rates from various lenders is one of the best ways to get a good rate. The main purpose of refinancing a car loan is to qualify for a lower interest rate, which can result in lower monthly payments. Credit bureaus usually combine inquiries of the same type, so try to compare rates within a week or two to avoid a big hit.
Check Your Credit Score
Checking your credit before applying for a loan is a good idea. Before you start applying for a refinance loan, run a credit report from the three major credit bureaus: Equifax, Experian and TransUnion. The US government allows all consumers to receive one free credit report each year from all major reporting bureaus.
Get Pre-Qualified
Most lenders offer a pre-qualification, also called a pre-approval, which is a letter stating the amount of money they are willing to give you, based on the terms of the loan you choose. Getting pre-approved shows you the amount of money you can spend, and at the interest rate, without agreeing to a loan and applying.
Avoid Applying for Other Types of Loans
When you apply for loan refinancing, avoid applying for any other type of loan at this time. Otherwise, you may be subject to multiple hard credit checks, which will further impact your credit score. Try to time your auto refinance for a time when you don’t need any other type of loan, such as a mortgage.
Can You Refinance a Car with Bad Credit?
While it is possible to refinance a car with bad credit, it is not always the best option. You usually need good to excellent credit to qualify for a better loan interest rate. With bad credit, finding a good interest rate may be more difficult.
However, you can still explore refinancing, even with bad credit. Getting pre-approved from several different lenders will show you the interest rate you qualify for. If you find a lower interest rate than what you are paying now, refinancing can be a good option.
Another thing to consider is using a co-signer on your refinance loan. If you have poor credit, co-signing a new loan with someone who has good credit can help you qualify for a better interest rate. However, refinancing with a co-signer who also has bad credit may not help.
Is It Worth Refinancing Your Car?
While refinancing your existing car loan may temporarily affect your credit score, the long-term cost savings are usually worth it. Refinancing can save you a lot of money, especially if your credit score has improved since you took out your current loan.
Lower monthly payments can also make it easier for you to pay off other loans you may have, which also improves your credit.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. He has extensive knowledge of various lines of insurance, including auto insurance and property insurance. His byline has appeared in dozens of online financial publications, such as The Balance, Investopedia, Reviews.com, Forbes and Bankrate.