If you’re considering applying for a new car loan, you may be wondering, “Does refinancing your car hurt your credit?”
When it comes to auto loans, there are many reasons why people refinance their cars.
The typical reason is to decrease interest rates. However, it can also be a great option if you want to save money on your monthly expenses or work on debt consolidation or have other budgetary changes.
While these are all good things, a lot of people get hung up on the question: “Will refinancing my car hurt my credit?”
Come on, let’s find out.
Does refinancing your car hurt your credit?
If you’re thinking of refinancing your vehicle, you may be wondering about its effect on your credit score.
It’s true that refinancing your car loan could cause a temporary dip in your credit score.
But most of the time, that isn’t a big issue. For one thing, most new loans take just a few months for your credit rating to return to normal.
Many people consider this small dip in their credit score to be worth the financial savings in the long term, such as lower interest rates or lower monthly expenses.
What happens when you refinance your car?
To understand how and why refinancing your car could hurt your credit score, let’s take a look at what happens when you refinance your vehicle.
When you refinance your automobile loan, you essentially use a new loan to cover the remainder of your existing loan.
It does just as it did when you first bought your car.
You get approved for a new loan
Approach banks or credit unions with financial support documents (e.g., proof of income and debt) to obtain loan offers. It’s best to approach multiple lenders so you can compare interest rates and fees to find the best loan.
The new lender pays off your old lender
Upon accepting the loan offer, your lender will pay you the remaining balance of your previous loan to your original lender.
Your new lender now holds your car lien
Then, your new loan provider takes over your lien on your vehicle. Essentially, if you default on payments or trade in your vehicle, your financing details are tied to your new loan provider.
Why does refinancing your car hurt your credit?
Is refinancing a vehicle harmful for credit? The answer is yes.
Hard inquiries
A big part of it has to do with credit checks and difficult questions.
When you apply for a new line of credit (such as a new loan when you want to refinance your car), each lender you apply to will request a hard credit inquiry. The hard inquiry will appear on your credit report.
Note that this is not the case with a gentle request. This will not affect your score.
Your credit score is calculated using scoring systems such as FICO and VantageScore. Whenever you have a hard inquiry placed on your credit report, it causes your credit score to briefly drop.
It may seem quite frightening when considering refinancing your automobile. For instance, if a new hard inquiry shows up on your credit report every time you apply for a new loan, your credit score could drop rapidly.
But scoring models suggest that you should shop around for various types of loans. If you apply for several different loans within a few weeks, it will be counted as a single event and will only appear as a single hard inquiry on your credit report.
Age of your accounts
But it doesn’t stop there.
If you are offered a loan, there may be a small decline in your rating because the credit line you are borrowing from is a new instrument.
This means that the age of your accounts affects your Total Credit Score.
Remember that when you refinance your car loan, you are actually paying off your original loan early and replacing it with a new one.
By borrowing money, you are lowering the age at which your cryptoassets start earning interest. This will add a very small dent to your credit rating.
What does refinancing mean for your credit score in the long term?
It can be a scary question: Does refinancing your car hurt your credit?
We know that refinancing your car and taking on a new loan will cause a small dip in your credit score—but what does this mean for your credit in the long term?
The good news is that even though your credit score will go down when refinancing, this probably will not have adverse long-term consequences.
It’s all about the way credit ratings are scored.
How refinancing your car can affect your credit score
Your credit score is calculated based on factors related to your debt and how you repay that debt, e.g., do you always make payments on time? What is your credit history length?
This refers to components of your score because they are used to estimate the likelihood you will pay your bill.
If you do get approved for a new car loan, your score takes a hit because the lender runs a credit check. Taking out the new loan increases your risk that you will miss payments and increases your score.
While this may all seem to add up to a significant hit to your credit score, it is typically not as bad as it sounds.
Because you’re refinancing (meaning you’re replacing an older loan with a new one of equal size), your credit score won’t be as big of an impact as it would be if you were to get a new loan of a different value.
Furthermore, the long-term effects of a missed payment are easy to avoid. After just a few months of missed payments, your rating will quickly increase.
As for the effect from the difficult inquiry (mentioned previously), that typically disappears from your rating within a year.
Your credit report will show your new loan.
So if you ask yourself, “Does refinancing your vehicle hurt your credit score?” the answer is actually twofold. No, it does not cause your score to decrease; the effects are not quite as long-lasting as you assume.
Pros of refinancing your car
Does the refinancing of my car hurt my credit? Yes.
That does not mean you shouldn’t refinance, however.
Now that you know how it all works and how refinancing your car can hurt your credit … why would you want to do it?
Refinancing your car can be financially beneficial.
You can use it to:
Save money on interest
This is perhaps the number one reason why many people refinance their auto loans. It is one of the most effective ways of saving money over the long haul.
As you shop around to refinance your car, be sure to examine average loan rates based on credit scores to give you an idea of market conditions.
Get lower monthly payments
Alternatively, you can refinance your car loan rather than to reduce your interest rates, but to reduce your monthly payment.
If you’re having trouble managing your monthly payments and want to reduce your expenditure, refinancing your loan may be a good option.
This means extending the length of your loan, but lower monthly payments are a small price to pay.
Pay off your debts faster
If you’re on a mission to pay off your debts quickly, then refinancing your car loan is a great way to go.
If you can afford to pay a little more every month for your car payments, you can switch to a shorter loan term to pay off your loan more rapidly.
Get fast access to cash
Refinancing may be necessary if people want to get money as soon as possible.
This is considered a cash-out refinance.
For example, if your car is worth $20,000, you will have paid $12,000. Based on what you’ve already paid, you owe $12,000. If you do a cash-out refinance for the full $20,000, you will be left with $8,000 in cash.
Be careful: This will mean you’ll likely have quite a substantial loan to repay once again and start over with a clean slate. But if your emergency fund is full, cash out refinancing might be able to help you.
Cons of refinancing your car
If you’re wondering, “Does refinancing my car hurt my credit?” you owe it to yourself to consider all of your options. You may be surprised to find that there are a lot of benefits to refinancing your car. But there’s nothing that says it’s the best choice for everyone at all times.
There may be some significant drawbacks to refinancing your car.
You have to pay refinancing fees
How much you have to pay in fees when refinancing your car will vary. You will likely have to pay something, however.
Everything from early termination fees to title transfer fees can rapidly add up to how much you will save by refinancing. And that could influence how much you hope to save over time.
You might actually pay more over time
When refinancing, the goal is to obtain a lower interest rate. However, you should also pay attention to the length of the loan.
Even if you refinance for a longer loan term, you will end up paying more in interest over time even at a lower interest rate.
You might go “upside down” on the loan
Refinancing can be risky, since you could end up getting upside down on your loan.
This results in you owing more than your vehicle is actually worth, which sometimes happens if you greatly extend your loan term.
Is right now a good time to refinance your car?
What about refinancing your car hurts your credit? Yes, but you must time it perfectly. When considering all the pros and cons of doing so, you need to consider if now is the right time for you to do so.
How do you know if it’s a good time to refinance your car?
It could be a good time if:
It might not be a good time if:
So are you ready to refinance your car?
Is refinancing a car harmful for credit scores? That question is usually not black or white.
There are many benefits to refinancing your car loan. If you think now is the time to refinance, you should take the steps necessary to put yourself in the best position possible to get the best loan possible.
How to prepare your credit score for refinancing
As you begin to refinance your car, one of the first things you should do is make sure your credit score is as good as possible.
Checking your credit score won’t affect how your credit score changes. It’s an important first stage, though. You may be able to get an idea of what sort of lenders will think of you when you are shopping for a loan.
Reviewing your credit report also allows you to discover incorrect information and contest it if necessary before applying for loans.
While you can’t improve your credit score overnight, if you are planning to refinance soon, there are a few things you can do to improve your score.
For example, you can use those funds to pay off any high credit card balances you may have. You can also continue to make all of your debt payments on time.
How to prepare to refinance your car
Now that you are ready refinance your car, it is time to examine all the advantages and disadvantages of doing so.
Does refinancing your car hurt your credit?
We know that it pays to do so. Now you know the financial benefits as well. Which can outweigh a temporary decrease in your credit score.
Still worrying about refinancing your car? Before you begin the process, read more on auto loans and car expenses!
