Refinancing your vehicle will likely cause a dip in your credit score because the application process usually involves a hard credit inquiry, which will temporarily lower your score. Additionally, accepting a loan can lead to another drop, as borrowers are statistically more likely to miss payments when they first take on a new debt.
That said, refinancing can offer big advantages, including lowering the cost of your loan over time and making your monthly payments more manageable. Depending on your situation, these benefits may be worth it — even if refinancing a car does temporarily hurt your credit.
Keep reading to learn more on auto loan refinancing, including how it can lower your credit score, factors that affect your credit score, and how auto loan refinancing may help your credit.
Key Points
• Refinancing a car loan typically involves a hard credit inquiry, which can temporarily lower your credit score by a few points.
• Opening a new loan account through refinancing can also slightly reduce your credit score, as it decreases the average age of your credit accounts.
• Refinancing can often lead to a lower interest rate, which can reduce your monthly payments and the total interest paid over the life of the loan.
• Consistently making on-time payments with the new, potentially lower, monthly payment can help improve your credit score over time.
• Refinancing may improve your debt-to-income ratio, making it easier to manage other financial obligations and potentially boosting your creditworthiness.
What Is Auto Loan Refinancing?
Auto loan refinancing involves taking out a new loan to pay off the balance on your original auto loan. Once you’ve applied for a new loan and your application is accepted, your new lender will take possession of the title of your vehicle. You’ll then begin making regular payments to the new lender. In some cases, you may refinance with your original lender.
There are both pros and cons of refinancing a car. Ideally, the new loan will offer a lower interest rate or lower monthly payments. However, you may also be on the hook for fees. Lenders charge fees for issuing a new loan, which can eat into whatever savings the new loan offers. Make sure these costs don’t outweigh potential savings.
As far as when to refinance a car, there are a few scenarios when it might make sense: if interest rates drop, your financial situation improves, or you’re looking for ways to lower your monthly payments.
If interest rates drop or you’ve built your credit score, you may be able to qualify for a loan with a lower interest rate than your current loan. Paying less in interest will reduce the cost of borrowing over the life of the loan.
You may also choose to refinance to a loan with a longer term. This can reduce the amount of your monthly payment. However, a longer term means you’ll pay more in interest over the life of the loan, which can ultimately make your loan more expensive.
Recommended: What Credit Score Do You Need to Refinance a Car?
Can Refinancing a Car Lower Your Credit Score?
Refinancing a car can temporarily lower your credit score due to the credit inquiry and changes in your credit accounts. When you apply for refinancing, the lender performs a hard inquiry to review your credit history, which may cause a small dip in your score. Additionally, refinancing replaces your existing car loan with a new one, which might reduce the average age of your credit accounts — a factor that impacts your score. However, these effects are usually minor and temporary.
It’s also important to note that if you’re shopping around for a loan (which is advisable), you don’t need to worry about getting hit with multiple hard inquiries. Credit score companies don’t want to deter borrowers from shopping around for the best loan, so they count multiple hard inquiries made over the course of a few weeks as one.
Factors That May Affect Your Credit Score
Hard inquiries aren’t the only thing that can affect your credit score. The five main factors that have an impact on your credit score include:
• Your payment history: This is the most important factor, accounting for 35% of your FICO® score. Lenders want to know that you have a track record of paying your bills on time. This helps them determine how risky offering a loan may be.
• The amount you owe: As the second biggest factor, this comprises 30% of your credit score. If you’re using a high portion of your available credit, lenders may see you as potentially overextended, putting you at higher risk of default.
• Length of credit history: This factor makes up 15% of your FICO score. FICO looks at how long you’ve had your credit accounts, as well as the last time you used them. In general, the longer your credit history, the better the effect on your score.
• Your credit mix: Generally speaking, FICO likes to see you have a mix of credit, such as credit cards, installment loans, and mortgages. This accounts for 10% of your credit score calculation.
• New credit: This factor also makes up 10% of your score. New credit, as mentioned above, can be a red flag to lenders who might worry it puts borrowers at greater risk of default.
Recommended: Can I Use a Co-Borrower When Refinancing?
Can Refinancing a Car Help Your Credit?
Refinancing a car can help your credit if it improves your ability to make on-time payments. By refinancing, you might secure a lower interest rate or extended loan terms, which can reduce your monthly payment. This makes it easier to stay current on your loan, as consistent on-time payments positively impact your credit score.
Additionally, refinancing can lower your debt-to-income ratio, a factor lenders consider when evaluating your creditworthiness. Over time, this could strengthen your overall credit profile.
Recommended: What Questions Should You Ask When Refinancing a Car Loan?
When You May Not Want to Refinance an Auto Loan
Refinancing your auto loan isn’t always appropriate. There are certain situations in which you might consider opting against refinancing, such as:
• If interest rates have risen since you took out your initial loan: In this scenario, it may be very difficult to find a new loan with a better rate. This may be true even if you’ve built your credit score.
• If your car is worth less than the amount you still owe: If you’re in this situation, you have an upside down car loan. Lenders may be hesitant to extend credit since if you default on your loan, they’ll be unable to recoup their losses by repossessing and selling your vehicle.
• If you’ve already paid off most of your loan: In this case, refinancing may not make much sense, as the cost of fees can offset the potential savings.
• If you’re planning to apply for another major loan soon: Remember that new credit will temporarily lower your credit score. So think ahead to whether or not you’ll be applying for another major loan in the near future, such as a mortgage. If so, you may want to put off refinancing until you’ve secured that loan at the best rate possible.
Recommended: Car Loan With a 650 Credit Score
The Takeaway
Refinancing a car can have both positive and negative impacts on your credit score. While the initial hard inquiry and opening of a new account might cause a slight, temporary dip, the long-term benefits of lower monthly payments and reduced interest rates can lead to improved financial management and, ultimately, a better credit score.
If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.
FAQ
How does refinancing a car affect your credit score?
Refinancing a car can temporarily lower your credit score due to a hard inquiry and the replacement of your old loan with a new one, reducing the average account age. However, it can improve your credit over time by making payments more manageable, helping you maintain consistent on-time payment history.
Why did my credit score go down when I refinanced my car?
Your credit score likely dropped when you refinanced your car due to a hard inquiry from the lender and the closure of your original loan. Refinancing creates a new loan, which can lower the average age of your credit accounts. These effects are usually minor and temporary with responsible repayment.
Does paying off a car loan affect your credit?
Yes, paying off a car loan can affect your credit by reducing your credit mix, which is a factor in your credit score. While it removes a debt obligation, closing the account may also lower the average age of your credit. However, the positive history of on-time payments remains beneficial.
Photo credit: iStock/Tero Vesalainen
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