There’s no denying that inflation and the Fed’s decisions to increase interest rates have put a lot of strain on borrowers. It’s part of the reason why the average car payment for a new car is a whopping $644 right now. Not only is that outrageous considering the increase in the cost of living, but that’s a double-digit increase year-over-year. However, the average car payment is even higher for used and leased cars, too. So if you’re thinking about refinancing your car, I absolutely understand. However, does refinancing a car hurt your credit?
It’s a common question I get a lot around here. The answer is that…it depends.
Refinancing an auto loan will likely have a small negative impact on your credit score, but that’s usually a temporary dip. In the long run, refinancing can save you money or help you avoid car payments you can no longer afford. Here’s what you need to know.
Is Refinancing a Car Right For You?
Before diving into how refinancing a vehicle can affect your credit score, it’s worth answering one big question first. Is refinancing a car even right for you?
Depending on several factors, refinancing an auto loan can be worth it. Here are a few situations in which it might make sense.
Interest Rates Are Down
If you see that interest rates are down, it may be a good time to refinance your auto loan. A drop of two or three percentage points could give you significant savings over the life of your loan.
This is especially true if you still have a couple of years left on your loan, refinancing could help you save money. However, be mindful of the fact that your credit score will ultimately determine the interest rates you get.
Before you refinance, consider your current financial situation and whether you can afford the new monthly payment. You’ll also want to compare interest rates and terms from different lenders to get the best deal.
Your Credit Score Has Improved
You may have taken out your loan when your credit score was low, and as a result, you were given a higher interest rate loan. But now that you’ve been paying your car loan on time, your credit score has likely improved.
That means you may be able to qualify for a better, lower-rate loan if you refinance now. So refinancing could save you money.
Of course, it’s not always the right move. You’ll need to consider things like how much money you’ll save and how long it will take to break even on the costs of refinancing.
Your Car Is Valuable
If you’ve been keeping up with the Kelley Blue Book value of your car and find that its value is still quite high then it could make sense to refinance.
Just make sure to check its resale value before applying so you know how much equity you have in the vehicle. If your car has depreciated in value and you owe more than it’s worth then it might not be the right move.
You Want to Add or Remove a Co-Borrower
You may wish to add or remove a co-borrower from your car loan for a number of reasons. You may have changed your mind about who you want as a cosigner, or your financial situation may have changed and you no longer need or want a cosigner.
You may also want to add a cosigner if you didn’t originally have one but now realize that it would improve your chances of getting approved for the loan or getting a lower interest rate.
Whatever your reason, if you currently have a car loan with another person listed as a co-borrower, you’ll need to refinance the loan in order to make changes to the borrower’s status.
You can usually do this by applying for a new loan through the same lender or through a different lender.
When you’re ready to begin the process, be sure to gather all of the required financial information so that you can provide it to the lender. You’ll also need to let your co-borrower know that you’re planning to refinance the loan and remove them as a borrower.
This way, they won’t be surprised when they receive notice that their name has been removed from the loan. You should also make sure that you’re prepared to take on full responsibility for repaying the loan, as removing a co-borrower means that you’ll be solely responsible for making all of the payments.
How Does Auto Loan Refinancing Work?
Think that it makes sense to refinance a car? Great! Now it’s time to learn about how auto loan refinancing works.
Basically, you use a new loan to pay off your current car loan. Ideally, this new loan has a lower interest rate or lower monthly payments. That’s what really makes auto loan refinancing worth it.
What happens with that new loan?
The new lender takes over the lien on the car. This means they’ll have the legal right to take possession of the car if you fail to make your payments. You’ll make payments to them now instead of the previous lender.
However, it’s important to keep in mind that you will likely need to have good credit in order to qualify for a lower interest rate. Additionally, you’ll need to make sure that the new loan term is shorter than your existing loan in order to avoid paying more in interest over time.
Does Refinancing a Car Hurt Your Credit?
So, does refinancing a car hurt your credit? In short, yes, it can. When you go to apply for a car refinance loan, the lender is going to ask for some information about your finances.
They’ll want to know how much money you make each month and what kind of debts you’re currently carrying. This information will help them determine what kind of credit risk you possess as a borrower.
Based on that risk, they’ll define the value of money that they’re willing to lend to you and an appropriate interest rate to charge for the duration of your loan.
What’s really important to know, though, is that as part of this process, you’ll also need to undergo a credit check and full loan application. These can temporarily hurt your credit score.
Hard Credit Check
When you are looking to take out a loan, the lender will always do a hard credit check in order to view in-depth credit history information. This type of check can ding your credit score, and it may stay on your report for up to two years.
The impact of a hard inquiry on your score depends on how good your credit is, to begin with. If you have excellent or good credit, one hard inquiry might not matter much. But if you have fair or poor credit, multiple hard inquiries could bring down your score significantly.
In general, it’s best to avoid hard inquiries if you’re trying to improve your credit score. However, as part of refinancing a car, it’s just an inevitable part of the process.
Multiple Loan Applications
Multiple inquiries for new credit lines on your credit report could be interpreted by lenders as indicating desperation for funds or an inability to manage current obligations.
When you’re looking for a new auto loan, you may be tempted to apply to multiple lenders in order to get the best rate.
However, it’s important to know that each time you apply for credit, the lender will do a hard pull on your credit report. This may give the impression that you’re a higher-risk borrower. That’s why it can sometimes lower your credit score a few points.
Fortunately, most credit scoring models will only count multiple inquiries from the same type of lender as a single inquiry.
When you refinance an auto loan, you essentially close out one account in order to open a new line of credit for your new loan. Closing this account can also slightly hurt your credit score because it ultimately decreases your length of credit history.
While it’s always suggested to keep old accounts open when you don’t use them (in the case of credit cards, for example), this isn’t really possible with a refinanced auto loan since the goal is to pay it off with your new loan.
This means that this is definitely a factor in terms of deciding whether or not refinancing is right for you. If you’re unsure, think about credit coaching to ensure it’s the right choice!
How Long Will Your Credit Score Be Affected After Auto Loan Refinancing?
Most credit scores will only be affected for about one year after you refinance your car loan. Does this mean it’s not right for you? Not necessarily.
How much your credit score is impacted by auto loan refinancing depends on how the new lender reports the new loan. It also depends on a few other factors in your credit report.
As mentioned, if you have excellent or good credit to begin with, the impact will likely be minimal.
Generally speaking, however, the impact on your score should be minimal if your payments don’t change drastically. However, if you extend the term of the loan, your score could be affected for longer.
Additionally, if the refinanced loan is reported as a new loan (rather than an extension of the existing loan), it could have a short-term negative impact on your score. But overall, the effect of auto loan refinancing on your credit score shouldn’t be significant.
Refinance a Vehicle: How to Reduce The Impact on Your Credit Score
As established, refinancing a car can help you save money on your monthly payments, but it can also impact your credit score.
Here are a few tips to help you reduce the impact of refinancing on your credit score.
Improve Your Credit Score Beforehand
Your credit score is important. It’s a number that indicates to lenders how likely you are to repay debt. The higher your score, the better rates you’ll be offered on loans.
If you’re considering refinancing your auto loan, it’s a good idea to check your credit score beforehand and take steps to improve it if necessary.
How do you improve your credit score easily and quickly? Always pay your bills on time, lower your credit utilization rate, and work towards paying off large debts.
Taking these steps will not only help you get the best rates on loans, but it will also save you money in the long run.
Shop for Loans Within a Short Timeframe
If you’re shopping for a loan, you may be concerned about the impact multiple inquiries will have on your credit scores.
Fortunately, most credit scoring models treat multiple inquiries from auto, mortgage, or student loan lenders as a single inquiry, so they shouldn’t have a significant impact on your scores.
However, it’s important to note that this only applies if you’re shopping for loans within a short timeframe.
Pre-Qualify for a Loan
Pre-qualifying for an auto loan is a very simple process that can save you a lot of time and hassle when shopping for your new car.
By getting pre-qualified, you’ll know exactly how much you can spend on a car, which will make the process of narrowing down your choices much easier.
In addition, many dealerships will give you preferential treatment if you have a pre-approval in hand, which means you’re more likely to get a better deal on your new car.
Improve Your Credit With Jeanne Kelly
So, does refinancing a car hurt your credit? It can, honestly, and the best way to prevent any blows to your credit is to prepare yourself beforehand. To do that, it’s best to speak with a trusted credit professional who can help guide you through the process.
For that, I’m here for you. With over 20 years of experience and numerous speaking engagements, I have poured all of my experience into my online class just for you.
Click here to begin learning about how you can take steps to improve your credit today.