Will Refinancing My Car Hurt My Credit Score?
Looking to refinance your car loan but not sure what it might do to your credit score? In this article we’ll discuss the main points to consider so you can decide if a car refinance is right for you.
When people consider a car loan refinance, it’s usually to take advantage of a lower interest rate, which will save money over the course of the loan, which for most people is a greater benefit than a decrease in credit score.
Read on to see which option is better for you!
Credit Union of Southern California (CU SoCal) is the fastest growing credit union in Southern California, providing some of the best checking, savings, and loan products available, quick pre-approvals, no application or funding fees, and more!
Call CU SoCal at 866.287.6225 to schedule a free no-obligation auto loan consultation, or apply online today!
What Is Car Refinancing?
Refinancing a car is very similar to the financing process car buyers engage in to purchase the car new.
The first step in a refinance is to shop around by talking to different lenders, such as your credit union or bank, about rates and loan terms.
You’ll apply for the new loan by supplying the necessary support documents (as you did for your current loan), such as earnings and debt, and wait for approval. During the approval process the lender will look at your credit score.
If approved, the remaining amount you owe on your first loan will be paid off and you will start making payments on the new loan, just as you did before.
The credit experts at Experian tell us that when you apply for loans to shop for the best rate, each lender you apply with will request a credit check that causes a hard inquiry to be entered on your credit report.
This typically causes a small reduction in your credit score. If you qualify for and accept a loan offer, you'll typically see another small score dip.
Because refinancing replaces an existing loan with another of roughly the same amount, its impact on your credit score is minimal. For more details read “How to Refinance a Car”.
How are Credit Scores Calculated?
Credit scoring awards points for factors related to your debt and how you repay that debt, such as on-time payments and length of credit history, which helps lenders predict who is most likely to repay a debt.
Not only is credit a consideration lenders use to determine eligibility to borrow, it plays a role in the interest rate you’ll be offered on a loan.
The most widely use credit scores are FICO® Scores, developed by Fair Isaac Company, Inc. FICO Scores are calculated using many different pieces of credit data in your credit report.
This data is grouped into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
How Refinancing Your Auto Loan Can Lower Your Credit Score
As you begin shopping for a car refinance loan, be prepared to provide lenders with information on your income and debts.
All lenders will want to do a credit check (hard inquiry) to see your credit score. If you’ve been making on-time payments to your current loan and any other loans you have, then your credit score will likely be good, very good or exceptional.
Multiple Loan Applications
Opening several credit accounts in a short period of time represents greater credit risk. When the information on your credit report indicates that you have been applying for multiple new credit lines in a short period of time (as opposed to rate shopping for a single loan, which is handled differently). Looking for new credit can equate with higher credit risk, but most Credit Scores are not affected by multiple inquiries from auto, mortgage or student loan lenders within a short period of time. Typically, these are treated as a single inquiry and will have little impact on your credit scores.
Closing An Account
Your FICO Score takes into consideration something called a Credit Utilization Ratio. This ratio looks at your total used credit in relation to your total available credit; the higher this ratio is, the more it can negatively affect your score. So, by closing an old or unused card, you are essentially wiping away some of your available credit and there by increasing your credit utilization ratio. However, if you close a credit account, try to close one that you recently opened, since long term credit accounts help improve your credit score.
How Long Will My Credit Score Be Affected?
As you start the loan application process, you’ll probably wonder, will refinancing my car hurt my credit? Refinancing and loan modifications will temporarily lower your FICO Scores in a few areas but can save you money with a lower monthly payment. Most credit scores will only be affected to about one year. How much a score is impacted depends on how it's reported and the additional information in your credit report.
According to MyFico.com, if the loan is reported as the same loan with changes, three pieces of information associated with the loan modification may affect your score:
- The credit inquiry
- Changes to the loan balance
- Changes to the terms of that loan
Overall, the impact of these changes on your FICO Score should be minimal.
If it's reported as a "new" loan
, your score could still be affected by the same three factors above along with the additional impact of a new "open date."
A new or recent open date typically indicates that it's a new credit obligation and, as a result, can impact the score more than if the terms of the existing loan are simply changed.
Is Auto Refinancing Worth It?
Refinancing an auto loan can be worth it, depending on several factors:
- Your Car Is Retaining Value: If you owe more than your car is worth, it’s generally not a good idea to refinance. Check your car’s value using Edmunds.com, Kelley Blue Book, or the National Association of Auto Dealers (NADA).
- Interest Rates are Going Down: If you see that interest rates have fallen since you took out your original auto loan, then it’s a good time to refinance, especially if you still have a couple of years left on your loan term. A drop of 2 or 3 percentage points could give you significant savings over the life of your loan.
- Your Credit Score Has Increased: If your credit score was low when you first took out your loan, there’s a good chance you were given a higher interest rate loan. Now that you’ve been paying your car loan on-time, your credit score has likely improved. Refinancing now could save you money because you’ll qualify for a better, lower rate.
- You Need Extra Cash: If you need cash to pay bills or consolidate debt, getting cash-out from a car loan refinance could give you the money you need. While you may benefit from a lower interest rate on the new loan, keep in mind your new loan will also cover the remaining balance on your original loan, resulting in a new, higher loan amount. With a cash-out auto refinance your new loan will be larger than your original loan. Your “cash out” will be the difference between the loan amounts, which will be deposited into your bank account.
- You Want to remove or Add a Co-Borrower: If you started your car loan with a co-borrower, such as a partner, spouse or parent, you may have a change of circumstances that requires you to take full ownership. Or, you may wish to add a co-borrower. Refinancing to a new loan allows for these changes to be made.
- You're Worried About Repossession: Failure to pay your car loan could result in repossession of the vehicle. If you find that you’re having trouble making your payments due to financial difficulties, refinancing to a lower interest rate can save you money, making it easer to pay your loan.
How to Reduce Impact on Credit
- Understand Your Credit Score: Knowing your credit score can help you understand the rates different lenders will offer. Consumers with a higher credit score are almost always offered better, lower interest rates on loans.
- Shop for Refinancing Loans Within a Short Period of Time: As we mentioned earlier, most credit scores are not affected by multiple inquiries from auto, mortgage or student loan lenders within a short period of time. Typically, these are treated as a single inquiry and will have little impact on your credit scores.
- Pre-Qualify: With a loan pre-approval or pre-qualification in-hand you’ll know how much you can spend on a new car, which will make shopping easier. A pre-approval from CU SoCal will let you shop with confidence.
How to Prepare to Refinance Your Car
Check Your Credit Score
To request your credit report visit www.AnnualCreditReport.com. Equifax®, Experian™, and TransUnion® are offering free weekly online reports through April 2021.
Or, you may contact each of the three major credit bureaus by phone:
Equifax: 800-685-1111 (option 3)
TransUnion: 800-916-8800 (option1)
Review Credit Reports and Fix Errors
If you find an error on your credit report you have a right to dispute the inaccuracy. There is no cost or fee to dispute mistakes or outdated items on your credit report. And, you don’t need to hire a credit repair company to do this for you. Simply contacting the credit bureau may resolve inaccuracies and may result in a credit score increase.
Shop Different Lenders
Not all lenders use the same lending guidelines, which means interest rates can vary. Look for lending promotions. Credit Unions, including CU SoCal, tend to offer lower interest rates on loans, than banks. Car dealers offer car loans through partnerships with lenders. Be sure to compare all of your options before you buy!
Does refinancing an auto loan affect your credit score? The answer is, it will somewhat affect your credit score, but the benefits of paying off your loan at a lower rate will generally outweigh the temporary reduction in credit score.
Refinance Your Auto Loan At CU SoCal Today!
We understand you’re more than a credit score, which is why CU SoCal lends on character and not just on credit scores. If you’ve been turned down for an auto loan because of a low credit score, or need help buying a car with bad credit, we can help. Learn more.
Please give us a call today at 866.287.6225 to schedule a no-obligation consultation with one of our auto loan experts.