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Does Refinancing an Auto Loan Hurt My Credit?

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Maria Neira
November 21, 2018

The main reason many consider refinancing their auto loan is the monthly savings that come as a result of getting a lower interest rate. When you go to a car dealership, you usually walk out with a higher interest rate than expected. It is always important to compare auto loan rates and go through the pre-approval process with outside lenders before you start shopping for a car. 

4 reasons to refinance your auto loan

  1. Settling on a high-interest rate when the purchase is initially made
  2. Your current auto loan term is too long
  3. Your credit score and financial status have improved
  4. Interest rates have dropped

The refinance process

It is quite simple to start the paperwork to refinance your auto loan. After you apply, you’ll hear back from the lender once they've reviewed your credit score along with your financial status. When you're approved, the lender will give you the full payment to pay off your old auto loan, so they can remove the lien from your car’s title. Your new lender will replace it with their lien. From that point on you will be responsible to pay down your new refinanced auto loan amount. 

Does refinancing affect your credit?

Any significant financial decision such as buying a car or refinancing a loan can have an impact on your credit. There are myths about drastic changes to your credit score when you refinance, so be sure to understand how your credit score is determined. There are five different sections of your credit that make up your score.

FICO uses the following:

  • Payment history – paying on time (35%)
  • Amounts owed – paying at least the minimum (30%)
  • Length of established credit (15%)
  • New credit lines – hard pull and soft pull (10%)
  • Credit mix – auto, mortgage, etc. (10%)

One thing that will affect your credit score a bit is a hard pull which is what lenders do when you apply for an auto loan. Another name for a hard pull is an inquiry which falls under the new credit line section of the calculation, so it will drop it a few points.

Mentioned above, shopping around for auto loan rates could affect your credit score but there is an allotted time period that varies from 14 to 45 days where you can get rates from different lenders and your credit score won't be hit with multiple hard pulls. 

When you refinance your auto loan, it basically closes that account and opens a new one that is added to your credit score. The scoring model will weigh closed accounts less than a new one being opened so the payment history of your credit score could possibly be affected since the payment history on the closed auto loan may carry less weight.

The length of the credit history section of your credit score may be impacted because closing an account may decrease the average age of your accounts and the length of them.

Can I refinance if I have bad credit?

Ideally, it is much better to refinance when your credit score is at its peak but refinancing with bad credit is still possible.

If you have bad credit, give it six months to a year of making payments on time because the lenders look for that when you go to them to refinance. It shows that you have a good handle on your payments and you are able to pay for your current auto loan. Even considering a credit repair company like The Credit Pro or CreditRepair.com can get you where you want to be. 

After a couple of months to a year, your on-time payments will result in a positive change to your credit score. Once your score reaches the best state possible then you can consider applying to refinance your auto loan. If you are denied for any reason, continue working towards a better score and give it a few more months.

Consider refinancing your auto loan if your rate is high

So, is refinancing worth it?

Of course, it may lower your credit score by a few points but in the long run, there are great benefits. You may have a shorter term, lower interest, and a more comfortable monthly payment. As long as you make your payments on time and don’t have issues paying the full amount your score will recover before you know it.

Priorities need to be in line so if you’re planning to take out a much bigger loan, for example, a mortgage, then refinancing your auto loan might not entirely be worth it because of the credit score point decrease. Your credit score should be in tip-top shape when you apply for any loan.