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Does refinancing a car hurt your credit?

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Refinancing a car loan can offer better loan terms and help you free up funds in your budget. However, you may experience a slight decrease in your credit score when you refinance. But don’t let that discourage you from considering refinancing your auto loan. It could be a smart choice that leads to cost savings and provides much-needed financial relief.

How refinancing a car loan affects credit

Refinancing a car loan can have an impact on your credit profile. This is because of your FICO credit score, which is a credit score provided by the Fair Isaac Corporation. FICO scores are determined by how well you manage your credit, including your payment history, outstanding debt, length of credit history, and even recent credit applications—such as applying to refinance your car loan.

Certain lenders may also utilize the Vantage Score model. Although Vantage credit scores are calculated in a slightly different manner, the act of refinancing will still result in a comparable decrease.

Applying for new credit and undergoing a hard inquiry can cause a slight decrease in your credit score due to these credit scoring models. Additionally, opening a new account will lower the average age of your credit accounts, which affects your overall FICO score. Now, let’s delve deeper into how refinancing a car loan can impact your credit.

It generates hard inquiries: Every time you apply for a loan, it triggers a hard credit inquiry, which may cause a slight decrease in your credit score. These inquiries stay on your credit report for up to two years, but their impact on your score lasts for only 12 months. Consequently, when you refinance a car loan, which involves seeking a new loan, it could temporarily affect your credit score.

It lowers your accounts’ average age: Refinancing can potentially decrease your credit score by lowering the average age of your accounts. However, the impact on your score is limited since account age only contributes 15 percent to your overall credit score. If you responsibly manage your new auto loan and other debt accounts, your score should recover quickly.

It has more impact if reported as a new loan: Refinancing your loan and having it reported as a “new” loan can significantly affect your credit profile. Not only will the refinance trigger a credit inquiry, but it will also create a new “open date” on your profile. This new open date indicates to credit agencies that you have taken on a new debt obligation, thereby increasing your overall debt load. It’s important to be aware of these potential impacts when considering a loan refinance.

How long will my credit score be affected by refinancing?

While refinancing a car loan may have an impact on your credit score, it is important to note that these effects are only temporary. With a few months of uninterrupted payments, your credit score should return to its previous level before refinancing. In fact, in some cases, it may even experience a slight increase. Additionally, if there are any hard inquiries associated with your refinancing, these score impacts will completely disappear within a year.

How to limit harm to your credit score

While refinancing may cause a temporary decrease in your credit score, there are strategies to mitigate its impact.

  • Get prequalified: Take the time to compare offers and find the most advantageous refinancing deal. After narrowing down your list of preferred lenders, obtain prequalification to explore potential financing options without any impact on your credit score.
  • Apply within a certain window: When you submit loan applications within a 14-day timeframe, most credit scoring models will treat them as a single inquiry. This practice, known as rate shopping, not only reduces the impact on your credit score but also streamlines the process.
  • Make timely auto loan payments: Your payment history holds utmost importance when it comes to your credit score. Under the FICO model, it contributes 35 percent, making it a significant factor. By ensuring timely payment of your loan every month, you can positively impact your credit score and facilitate its recovery.
  • Wait to open additional credit accounts: Refinancing can result in a decrease in your credit age. To potentially boost your credit score, it’s advisable to refrain from opening new credit accounts after refinancing. This approach aids in enhancing this metric over time.

The bottom line

Refinancing your car loan comes with both benefits and drawbacks. While it may cause a temporary dip in your credit score, the financial advantages often outweigh the potential damage. Moreover, there are strategies to minimize the impact on your credit score and facilitate its recovery when you apply for refinancing.

Before making a decision about refinancing, it’s important to become familiar with the process to avoid any unexpected surprises. Additionally, take the time to research different refinancing lenders, get prequalified, and carefully analyze the numbers. By doing so, you’ll be equipped to make an informed decision with confidence.

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