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Refinancing a car can cause a small, temporary dip in your credit score, but that can be a small price to pay to secure better terms or a lower monthly payment, or it allows you to pull some much-needed cash out of your equity.
Read on to learn what you need to know about how auto loan refinancing affects your credit score, how to determine whether refinancing is the right move and steps you can take to improve your credit after you complete the process.
Why Refinancing a Car Can Affect Your Credit
When you refinance a car loan, you're replacing your current loan with a new one, often without changing the loan balance. But the process can affect your credit score in a few ways:
- Hard inquiry: When you apply for a loan, the lender will typically run a hard inquiry on one or more of your credit reports, which can temporarily knock a few points off your score. If you choose to shop around for a loan, complete your rate shopping within 14 days to ensure that all the inquiries are combined for scoring purposes.
- New account: Opening a new credit account lowers the average age of your accounts, which can also have a slight negative impact on your credit score. This effect may be more pronounced if you have a relatively thin credit file.
- Potentially higher balance: If you do a cash-out auto refinance, you'll end up with a higher loan balance than you had initially, with the difference disbursed to you directly. Adding more debt to your credit history could also negatively affect your score.
Note: When you close a loan in good standing, it remains on your credit reports for 10 years, continuing to have a positive impact on your credit. If there's negative information tied to the account, such as a late payment, it'll remain on your credit reports for up to seven years.
How Much Will Your Credit Score Drop Due to a Refinance?
There's no easy way to predict exactly how your credit score will change after refinancing because the score itself is based on the entirety of your credit profile.
An individual hard inquiry usually takes fewer than five points off your FICO® Score☉ Θ and five to 10 points off your VantageScore® credit score. But beyond that, it'll depend on how long you take to rate shop, the length of your credit history, whether you're doing a cash-out refinance and other aspects of your credit history.
Still, you likely won't see an impact to the point where it significantly affects your ability to obtain credit.
How Long Does a Refinance Affect Your Credit?
The dip usually fades within a few months. Hard inquiries can stay on your credit report for up to two years, but they stop factoring into your FICO® Score after one year. While it can take your average age of accounts more time to recover, your length of credit history only makes up 15% of your FICO® Score.
Your payment history is ultimately the most important factor, making up 35% of your FICO® Score. So as long as you pay your bills on time, you likely won't see any long-term issues.
Learn more: What Affects Your Credit Scores?
Pros and Cons of Refinancing a Car
Refinancing can offer some benefits, but it's not always the right move. Here are some advantages and disadvantages to consider.
Pros
Lower interest costs: A lower rate reduces the total you'll pay over the life of the loan. Since auto loans often run into the tens of thousands of dollars, even a percentage point or two can add up to meaningful savings.
Smaller monthly payment: Stretching your remaining balance over a longer term lowers what you owe each month, which can free up room in a tight budget. This may be worth doing even at the same interest rate if it keeps you from missing payments.
Potential access to cash: If you owe far less than what your car is worth, you could tap some of that equity to consolidate debt, cover emergency expenses or just about anything else.
Cons
A temporary credit score dip: The hard inquiries and the new account will likely shave a few points off your score for a few months.
Fees can eat the savings: Your current lender may charge a prepayment penalty, often around 2% of your outstanding balance, and the new lender may charge an origination fee. Make sure to include these costs when running the numbers.
A longer term costs more overall: Lowering your monthly payment by extending the loan usually means paying more in total interest, possibly even with a lower rate.
Should You Refinance Your Car?
The decision to refinance depends on current interest rates, your credit profile, your financial situation and your goals. With that in mind, here are some scenarios where it could make sense to refinance and also when you should think twice.
When to Consider Refinancing Your Car
- Your credit score has improved. If your score is higher than it was when you took out your current loan, it's possible that you may qualify for better terms.
- Market rates have dropped. Even if your credit hasn't changed much, you may still be able to take advantage of lower market rates.
- Your monthly payment has become a strain. Refinancing your loan to extend your term may cost you more in interest, but it beats the threat of repossession.
- You want to access your equity. If you have significant equity in the vehicle, a cash-out refinance could be a good way to consolidate high-interest credit card debt or cover unexpected expenses.
- You have plenty of time left on your loan term. The longer you have left on your repayment term, the more you stand to gain from a lower interest rate.
When to Avoid Refinancing Your Car
- You're near the end of your loan term. If you only have a year or two left on your loan, it might not make sense to extend that another three years or more with a refinance loan. Even if you can secure a lower interest rate, the total interest costs would likely outweigh the potential savings.
- Your credit score has worsened. If your credit is worse off now than when you took out the loan, you'll likely have a hard time getting approved for better terms than what you're paying now.
- Market rates are higher. Even if your score has improved, higher interest rates may work against you.
- You owe more than the car is worth. Most auto lenders won't refinance an underwater auto loan, and those that do may charge higher rates and fees, minimizing your chances of saving money.
- The fees outweigh the savings. If a prepayment penalty or origination fee costs more than you stand to gain on the transaction, it isn't worth it.
How to Improve Your Credit After Refinancing
The credit score dip from refinancing usually fades on its own as you practice good credit habits. But if you're looking for more concrete steps you can take, here's what you can do:
- Pay on time. Payment history is the biggest factor in your credit score. Setting up autopay or calendar reminders for the new loan, along with your other debts, will help prevent costly missed payments.
- Keep your credit utilization low. Credit utilization is the share of your available credit card limits you're using at a given time. People with excellent credit tend to keep theirs below 10%.
- Avoid closing old accounts. Unless you're at risk of overspending, keep your old credit cards open, even if you're no longer using them. They can help keep your utilization low and bolster your length of credit history. If the account has a costly annual fee, ask your card issuer about downgrade options.
- Limit new applications. Each new application for a loan or credit card adds another inquiry to your credit reports, and multiple inquiries can have a compounding negative effect on your credit score. In general, it's best to space out applications by six months.
- Monitor your credit. Keep an eye on your credit reports and score to track your progress and spot potential threats before they take root. With Experian's free credit monitoring tool, you'll get access to your Experian credit report and FICO® Score, along with real-time alerts and insights.
Learn more: How to Improve Your Credit Score Fast
Frequently Asked Questions
Can Refinancing a Car Ever Help Your Credit?
Refinancing a car may not initially help your credit, but if it makes your payment more affordable, it could help you stay on time and prevent possible damage from missed payments.
Can You Refinance a Car With Bad Credit?
There's no universal minimum credit score requirement, so it's possible to refinance with bad credit. In fact, some lenders specialize in working with borrowers with bad credit. The rate you're offered may not beat your current one, though, so compare carefully before you commit.
The Bottom Line
Refinancing a car can save you money over the long term, reduce your monthly payments or both, easing your household budget. Before you get started, carefully evaluate your situation and goals to determine whether refinancing is the right move for you. Then, check your FICO® Score powered by Experian data for free to find out where you stand.
While it may be tempting to go with the first offer you see, shop around with at least a few lenders so you can compare offers and choose the best one for you.