Does Refinancing A Car Hurt Your Credit? [Find Out Here]

Shawn Manaher
Shawn Manaher
Updated on December 2, 2022 Featured Image TITLE

Need to refinance your car but aren’t sure about the impact it will have on your credit score? Read this guide.

A credit score is extremely important because it determines how easily you can get things like a credit card and a mortgage. If you are looking to refinance your car, you are probably wondering how this will affect your credit score.

When you first refinance your car, you might see a slight dip in your credit. Refinancing usually does not hurt your credit in the long run. The benefits of refinancing your car generally outweigh the cons.

Refinancing your car can offer lower interest rates and a lower monthly payment. This way you can have some extra money to pay all your bills. The money you save in interest is also well worth a small ding in a temporary ding in your credit score.

Why Does Refinancing Lower Your Credit Score?

Refinancing your car requires you to apply for a loan. Anytime you apply for a loan, the lender will make a hard inquiry into your credit which will lower your credit score. These hard inquiries into your credit will usually impact your score for about twelve months. However, it can be two years before you see them drop off your account completely.

Refinancing can also lower the average age of all the accounts you have. If this happens, you will see a decrease in your credit score. The length of your credit history accounts for 15 percent of your credit score, so you can see a slight drop in your score when the age of accounts decreases.

If you are paying back your new loan and making all the monthly payments in time, the slight decrease in your credit score will only last a few months. The financial benefits are also doing more good for you than a credit score that is a couple of points higher.

Limiting Harm To Your Credit Score

Reading that your credit score might drop can be scary. Luckily there are a few things you can do before refinancing that will help to limit the impact of your credit score possibly dropping. Minimizing the impact can help you feel better about refinancing your car loan.

One of the best ways to minimize impact is to make sure you’re prequalified for loans. Applying to loans without knowing if you’re qualified is dangerous because each of those lenders will check your credit score, which means multiple hard inquiries.

When you apply to lenders and are prequalified, you’re more likely to get approved, which means less time applying to lenders and potentially getting denied.

Your timing is also important. If you apply for loans within a 14-day period, most credit bureaus will group it together into one single inquiry rather than having a bunch of different ones listed. This can help your credit score to only drop a single point.

Since monthly payments are 35 percent of how your score is determined, you need to make sure you make monthly payments on time every month. Not making monthly payments on time can significantly drop your credit score and make it hard to get loans in the future.

Since your credit age will drop after getting a new car loan, you might want to not open any other accounts right after getting the new car loan. Holding off on new accounts will make sure your credit age doesn’t drop further.

How Does Refinancing A Car Loan Work?

Before refinancing a car loan, it’s important to make sure you know how it works. If you think you are ready to refinance, you can start by following these steps.

Check Your Credit

Before applying for any financing or loans, it’s important to know your credit score. Knowing your credit score will allow you to know which types of lenders and loans you are most likely to be approved for. In most cases, you probably only will qualify for loans with good interest and low rates if your credit score is in the very good or excellent range.

This means you need at least a credit score or 670 to get the loans with the lowest interest rate. Before taking out a new loan, you also want to make sure the new loan has better rates than your current loan.

Once you have determined your credit is in good standing and you can get a new loan, you can start shopping around and choose the lender with the best terms for you.

Look For Loan Offers

You should never just choose one loan offer. Always shop around and look at many different lenders to find one with the best terms and conditions. Some people find better luck with online lenders while others find loans at banks which they have current accounts with. You can try both.

You can also make a list of all the lenders you are pre-qualified with and then go through them and see which ones work the best for you. You should also read reviews of the company to see how other people feel about having loans with them.

Submit An Application

Being pre-qualified for a loan is not the same as applying. Even when you are prequalified you need to submit a formal application to the loan company. This can be found on their website. You will need to enter in some personal information. Once your application has been received, they will check your credit score and determine if they are willing to offer you a loan or not.

Just because you are pre-qualified does not mean you will receive the loan but it means you have a good chance.

Some companies will give you a decision right away while others might take a few days to notify you.

Sign The Closing Documents

Once you have been approved for a loan, the lender will send you various documents to sign. You will need to read through them and sign before they will give you the funds. Make sure to read through the papers and ask the lender any questions you have before signing.

The lender will then give you a check or out the money in your account, and you can pay off your current loan and then start to make monthly payments on the new loan. Always make sure you know when your first monthly payment is due.

When Should I Refinance My Car Loan?

There are many cases where you might want to refinance your car loan. The main one is that you feel like your current loan does not have the best interest rates, and you are paying more than you should.

You might also have a high monthly payment that you’re struggling with. If you find it hard to pay all your other bills because of your car payment, it might be time to look into refinancing options. If you are going through any kind of financial rough patch, refinancing your car loan can help you get a lower car payment.

Keep in mind that a lower monthly payment might mean you are paying more interest over the long run. Make sure you weigh the pros and cons before taking a loan with a lower payment but higher interest.

Usually, to be able to refinance a loan, you need to have a better credit score than what you started with. This means your auto loan rates have improved, and you can get better terms. If you currently have your loan through the dealership, you might want to look at the bank or credit unions to see if they have better deals.

Refinancing is always necessary if you want to add or remove a co-borrower to the loan. You will need to refinance with just your name or add the borrower you want to add to make sure they are financially responsible for the loan just like you are.

If the lender can only offer you the same interest rate, you can still see if they offer a longer time to pay back the loan, which means you’ll have more time to pay back the loan and smaller monthly payments. 

In Closing

As you can see, refinancing your loan usually comes with a slight drop in your credit score. It shouldn’t last more than 12 months, and the added benefits of refinancing your car loan are worth much more than the drop in credit score since you will have lower interest and a lower monthly payment.

There are also some steps you can take to minimize the drop in your credit, such as only applying for loans you are pre-qualified for. You can also make sure to apply for the loans in 14 days so that there is only one hard inquiry on your credit report rather than several.

Shawn Manaher

Shawn Manaher

Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author.

He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.

He loves to share his personal finance tips and money management wisdom with others to help them find financial freedom.
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