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 a lot of different reasons people turn to refinancing.
Most commonly, people do it to lower their interest rate. But it can also be a good option if you want to get a lower monthly payment, work on debt consolidation, or make other adjustments to your monthly budget.
While these are all good things, a lot of people get hung up on the question: “Will refinancing my car hurt my credit?”
Let’s find out.
Does refinancing your car hurt your credit?
If you've started thinking about refinancing your car, you might be concerned about what it can do to your credit.
It's true that refinancing your car loan can cause a temporary dip in your credit score.
But in most cases, this isn't that big of a deal. For one, after the new loan comes into effect, it usually doesn’t take too long for your credit score to get back to normal.
For many people, this small dip in their credit score is well worth the financial savings in the long run, such as lower interest rates or lower monthly payments.
What happens when you refinance your car?
To understand why and how refinancing your car can hurt your credit score, let’s look at what actually happens when you refinance your car.
When you refinance your car loan, you basically use a new loan to pay off the remainder of your current loan.
It works just like it did when you first bought your car:
You get approved for a new loan
First, you approach banks or credit unions with all your support documents (e.g., proof of earnings and debts) to apply for loan rates. It’s smart to approach multiple lenders so you can compare interest rates and fees to get the best loan possible.
The new lender pays off your old lender
Once you receive and accept the new loan offer, your refinancing lender will send a payment to your original lender for the remaining balance on your current loan.
Your new lender now holds your car lien
Then, the new lender takes over the lien on your car. Essentially, if you default on payments or trade in your car, your loan details are tied to your new lender.
Why does refinancing your car hurt your credit?
So, does refinancing a car hurt credit? The short answer is yes. But why does it hurt your credit? Here's a breakdown of why:
A large part of it has to do with credit checks and hard inquiries.
When you apply for a new line of credit (like a new loan when you want to refinance your car), each lender you apply to will request a credit check. A hard inquiry will appear on your credit report.
Note that this is different than a soft inquiry, which will not affect your credit score.
What does a hard inquiry do to your credit score?
Your credit score is calculated by different scoring models like FICO and VantageScore. And every time there is a hard inquiry pulled on your credit, it causes your score to temporarily dip.
This can seem pretty scary when you’re thinking about refinancing your car. After all, if there’s a new hard inquiry on your credit report every time you apply to a new lender, this could cause your credit score to fall fast.
But scoring models actually want you to shop around for different loans. So if you apply to several lenders within a few weeks, it will all be considered as a single event and, therefore, will only show up as one hard inquiry on your credit report.
Age of your accounts
But it doesn’t stop there.
Once you are qualified for and accept a new loan offer, there is usually another small dip in your score because you are taking on a new line of credit.
This affects the age of your accounts, which is another contributing factor to your overall credit score.
Remember that when you refinance your car loan, you are really paying off your original loan early and replacing it with a different one.
By taking on a brand-new loan, you are reducing the average age of your accounts, which can add another small ding to your credit score.
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 great news is that even though your credit will take a small hit when you refinance, it likely won’t have bad long-term effects.
It all has to do with the way credit scores are calculated.
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?
These are factors of your score because they attempt to predict how likely you are to repay your debt.
Your credit score might dip when you apply for new credit
So when you do an application for a new loan, your score takes a hit because the lender runs a credit check. When you accept that new loan, your score takes another hit because you are taking on new debt, which statistically puts you at a greater risk of missing payments.
Usually, a dip when refinancing a car is only temporary
While this can all seem like it’s totaling up to take a big hit to your credit score, it’s usually not as bad as it sounds.
For one, because you’re refinancing (which means you’re replacing an old loan with a new loan of basically the same amount), the impact on your credit score won’t be as big as it would be if you were to take on a new loan of a completely different, higher value.
Plus, the long-term effects are usually easy to avoid. In most cases, after just a few months of unmissed payments, your score will go back up.
As for the effects of the hard inquiry (mentioned earlier), that usually disappears from your credit score within a year.
On your credit report, you’ll see your new loan appear. Your original car loan will stay on your report for up to a decade, but it will be marked as “closed in good standing.”
So when you ask yourself the question, "Does refinancing your car hurt your credit?" The answer is really twofold. Yes, it does cause your credit to drop; but the effects are not always as long-lasting as you fear.
Pros of refinancing your car
Does refinancing your car hurt credit? Yes.
But does that mean you should never refinance? Not necessarily.
Now that you know how it all works and how refinancing your car can hurt your credit … why would you want to do it?
There are actually a lot of ways that refinancing your car can be financially beneficial.
It can help you:
Save money on interest
Perhaps the number one reason people refinance their car loans is to try to get a lower interest rate. This is one of the biggest ways for you to save money over time.
As you shop around to refinance your car, make sure you check out average loan rates based on credit scores to give you an idea of market conditions.
Get lower monthly payments
Alternatively, you might look to refinance your car loan—not to slash your interest rates—but to cut down your monthly payment.
If you’ve been struggling with budgeting and need to reduce your monthly expenses, refinancing your loan can be a good option.
While this does mean extending the length of your loan, it can help you financially now if you need smaller monthly payments.
Pay off your debts faster
If you’re on a mission to quickly pay down your debt, then refinancing your car loan can help you.
If you can afford to spend a bit more each month on your car payment, you can change your loan to a shorter term to help you pay it off faster.
Get fast access to cash
Sometimes people refinance because they need to get their hands on some cash fast.
This is known as a cash-out refinance.
For example, suppose your car is worth $20,000. Based on what you’ve already paid, you owe $12,000. If you do a cash-out refinance for the full $20,000, you’ll be left with $8,000 in cash.
Beware: This means you’ll have a pretty big loan again and will need to start from the beginning to pay it off. But if you’re in a tight spot and can't turn to your emergency fund, a cash-out refinance may be able to help you.
Cons of refinancing your car
If you're thinking, "Does refinancing your car hurt your credit?" it's worth taking the time to consider all your options. There can be a lot of benefits if you refinance your car smartly. But that doesn’t mean it’s the right choice for everyone all the time.
There can be some significant drawbacks to refinancing your car:
You have to pay refinancing fees
Exactly how much you’ll have to pay in fees when refinancing your car will vary. But you’ll definitely have to end up paying something.
From early termination fees to title transfer fees, application fees, and more, this can all quickly add up. And it may affect how much you hope to be saving in the long run from refinancing.
You might actually pay more over time
When refinancing, the goal is usually to get a lower interest rate. But don’t forget to pay attention to the length of the loan, too.
Even with a lower interest rate, if you refinance for a much longer loan, you can actually wind up paying more money in interest over time, even at a new lower rate.
You might go “upside down” on the loan
The biggest risk with refinancing is that you could potentially go upside down on your loan.
This means you end up owing more for your car than it’s actually worth. This can sometimes happen if you drastically lengthen your loan term.
Is right now a good time to refinance your car?
So does refinancing your car hurt your credit? Yes, but timing is everything. When you’re considering all the pros and cons of whether or not you should refinance your car, you also need to consider if now is the right time for you to do it.
How do you know if it’s a good time to refinance your car?
It could be a good time if:
- Interest rates are low
- You are trying to figure out a way to cut your monthly expenses
- Your credit score has significantly increased recently
- You want to add or remove co-borrowers
It might not be a good time if:
- Interest rates are high
- You’ve already paid off most of your loan
- Your car’s resale value has been reduced (e.g., it has high mileage or is damaged)
- You know you’ll be applying for another large loan soon
So are you ready to refinance your car?
When you ask yourself, “Does refinancing a car hurt credit?” the answer is generally yes. But it’s simply not that black and white.
There can be a lot of benefits to refinancing your car loan. If you think that now is the right time for you to refinance, make sure you take the necessary steps to get yourself in the best position possible for the best loan possible.
How to prepare your credit score for refinancing
As you get ready to start the process of refinancing your car, the first thing you want to do is make sure your credit score is as good as it can be.
Review your credit reports and then fix any errors
Simply checking your credit score is not going to cause it to change. It's an important first step, though. It gives you some idea of what lenders may think when they’re sizing you up for a loan.
Reviewing your credit report also gives you the chance to identify any errors and dispute them if needed before applying for loans.
Take steps to increase your credit score
While you can’t dramatically change your credit score overnight, if you know you are planning on refinancing soon, there are some steps you can take to work on boosting your score.
For example, you can work on paying down any high credit card balances you have. You can also continue to make all your debt payments on time.
How to prepare to refinance your car
Okay, you’ve weighed all the pros and cons of refinancing your car and have determined that now is a good time for you. Here’s what you can do to prepare:
- Check your credit score again
- Shop for different rates in a short period to avoid multiple hard inquiries
- Get pre-qualified for a loan
Does refinancing your car hurt your credit?
We know that it does. But now you also know the financial benefits of refinancing. Which can far outweigh a temporary dip in your credit score.