Refinancing a car loan could allow you to get better loan terms and free up funds in your budget. But how will this affect your credit score?
It’s a valid question, and the reality is that you’ll probably see a small drop in your credit score. Still, you shouldn’t necessarily avoid refinancing just because of a temporarily lowered score, as it could be a smart move that could result in huge cost savings or much-needed financial relief.
How Refinancing a Car Loan Affects Credit
Each time you apply for a loan, a firm credit application is generated, which may cause your credit score to drop slightly. Serious inquiries stay on your credit report for up to two years, but only impact your score for 12 months. Therefore, refinancing an auto loan — which is applying for a new loan — could temporarily affect your credit score.
Refinancing also reduces the average age of your accounts, which can lower your credit score. The good news is that the length of your credit history is only 15% of your credit score, which means it can bounce back quickly by responsibly managing your new car loan and other debt accounts.
How to limit the damage to your credit score
Although your credit score may drop when you refinance, there are ways to minimize the impact:
- Get prequalified. Shop around for the best refinance deal. Once you have a shortlist of preferred lenders, get prequalified to see potential financing offers without affecting your credit score. Plus, you’ll avoid taking multiple hits to your credit score by only applying with lenders who match your financial and credit profile well.
- Apply in a certain window. If you submit loan applications within 14 days, most credit reporting models will consolidate them into one application. This is called rate shopping and can also minimize the impact on your credit score.
- Make timely auto loan payments. The most important element of your credit score is your payment history. It’s 35%, so paying your loan on time each month will help your credit score bounce back sooner rather than later.
- Refrain from opening additional short-term credit accounts. Your credit age will decrease when you refinance. However, delaying opening new credit accounts after refinancing will help improve this number and possibly increase your credit score over time.
How auto loan refinancing works
When you’re ready to refinance your car loan, follow these steps to make the process smoother:
- Check your credit. Review your credit report to make sure it contains no errors and file disputes to resolve any issues you find. It’s equally important to check your credit score to see where you stand, as you’ll likely need at least a 670 to get a new loan on great terms.
- Find the best loan offers. There’s no shortage of auto loan refinance options, so you’ll have to shop around for the best deal. Consider reading reviews and getting prequalified to see loan offers you might qualify for.
- Submit a formal request. Most banks, credit unions and online lenders offer simple online applications – or you can visit a branch or call to apply. You may receive a loan decision immediately, but the financial institution may take some time to finalize the closing documents.
- Seal the deal. Review the loan documents and direct any questions or concerns to the lender. Sign on the dotted line and the new lender will provide you with a check to pay off your current loan or handle the transaction directly.
When to refinance your car loan
There are several reasons why refinancing your auto loan might make sense. However, you should only move forward when the time is right.
If auto loan rates have dropped since you took out your auto loan or your credit score has improved, and you can now qualify for a better rate, refinancing is worth considering. This is also the case if you got financing through the dealership and your bank or credit union has a better deal available.
Refinancing is also a good idea if you’re going through a tough financial time and need to lower your car payments to free up some cash. Even if you receive the same interest rate, the lender may extend the term of the loan to give you more time to pay. Keep in mind that you can pay significantly more interest over the life of the loan, despite having a lower monthly payment.
You must also refinance if you need to add or remove a co-borrower from the loan.
Refinancing an auto loan can temporarily hurt your credit score. However, the financial benefits you may receive can more than offset a drop in your credit rating. There are also ways to minimize the impact on your credit score and help it rebound relatively quickly when you apply for refinancing.
Before deciding if refinancing makes sense, familiarize yourself with the process to avoid any surprises. Also, explore lenders, get pre-qualified and analyze the numbers to make an informed decision.