How Refinancing Your Auto Loan Impacts Your Credit Score

If you’re thinking about refinancing your auto loan, you’re probably wondering how it will affect your credit score. After all, your credit score is super important when it comes to getting approved for loans and credit cards. So will refinancing hurt or help your score? Let’s break it down.

What is refinancing?

When you refinance a loan, you take out a new loan to pay off your existing one. For an auto loan, this usually means getting a new loan with better terms, like a lower interest rate or monthly payment. To get approved, the lender will check your credit.

Refinancing requires a hard credit check

When you apply for new credit, like a refinanced auto loan, the lender does a “hard inquiry” on your credit report. This is different from a “soft inquiry,” which doesn’t affect your score at all. Hard inquiries can ding your credit score a few points.

The good news? The impact is temporary. Your score will likely bounce back in just a few months. And if you rate shop and apply for multiple loans within a short time frame, the inquiries will generally be bundled and count as just one hard inquiry.^[1]

It can lower the average age of your credit history

Length of credit history is a factor in your score too. When you pay off your old auto loan, you lower the average age of your accounts. Again though, if you already have a long credit history, the impact should be minor.

Weighing the pros and cons

So yes, refinancing can cause a slight, temporary dip in your credit score. But often, the benefits outweigh a small drop. Let’s compare:

Potential cons of refinancing:

• A few points off your credit score
• Lower average age of credit history

Potential pros of refinancing:

• Lower monthly payments
• Lower interest rate, so you pay less over the loan term
• Ability to get out of an upside down loan
• Changing from a variable to fixed interest rate

For most people, the pros of refinancing outweigh the temporary credit score dip. Just focus on bringing your score back up over the next few months through on-time payments.

When is refinancing a bad idea?

Refinancing isn’t always the right move. Here are a few times to think twice:

• You plan to apply for more credit soon. Multiple hard inquiries in a short time frame look bad.
• You already have high interest debt. The hard inquiry could drop your score enough to hurt your rates.
• You’re close to paying off the loan. Refinancing restarts the clock.
• The new loan terms aren’t much better or have high fees.

Improving your credit before refinancing

Want to refinance but need to boost your credit first? Here are some tips:

• Pay all bills on time, including credit cards and existing loans.
• Pay down credit card balances, as high utilization hurts your score.
• Hold off on new credit applications until after refinancing.
• Check your credit report for errors and dispute any you find.

Give yourself at least 3-6 months of diligent credit management and your score should improve.

Alternatives to refinancing

If refinancing isn’t right for you, here are a couple other options:

• Defer payments – Ask your lender if they offer payment deferrals for hardship. This pauses payments without a credit check.
• Modify the loan – You may be able to modify the loan terms without refinancing, like extending the repayment term to lower payments.

Just keep in mind modifications can also extend the loan length. Refinancing may still get you the best terms overall.

The bottom line

Refinancing your auto loan can temporarily ding your credit score a few points due to the hard credit check. But for most borrowers, the benefits like lower payments or interest rate outweigh this small drop. As long as you continue practicing good credit habits, your score will recover within a few months.

The most important thing is understanding your options and choosing the one that best improves your financial situation. Don’t let a small temporary credit score drop stop you from refinancing if the new loan terms are significantly better.

References

[1] https://www.bankrate.com/loans/auto-loans/how-refinancing-an-auto-loan-affects-credit/