Refinancing a car allows you to take on a new loan to pay off your previous balance. You’ll have a new interest rate, along with new loan terms to be paid via a fixed payment over a certain period of time. After refinancing is complete, your new lender will send a payment to the original lender to cover the remaining balance and will take ownership of the lien against your car.
Most people seek refinancing to lower the interest rate on the amount that they owe. However, even if a lower interest rate isn’t available, you may be able to lengthen the term of your loan and reduce your monthly payment. In this case, you may wind up paying more interest, but your monthly expenses could be more manageable. Regardless of the reason you’re considering an auto refinance loan, it’s important to weigh the effects that such a loan could have on your credit.
How Refinancing Could Affect Your Credit
Since you are requesting a new line of credit, refinancing your car will affect your credit rating. In fact, there are many factors throughout the refinancing process that can have a negative effect on your credit. These include:
- Application inquiries. When you apply for the credit necessary to refinance your car loan, the lender or lenders involved will check your credit. These are called hard inquiries and can cause a minimal lowering of your score for about six months. Fortunately, if you are shopping around for favorable interest rates, credit bureaus can bundle credit application inquiries of the same type and within the same time period together, resulting in a single dip in your credit score.
- Age reduction. Among other considerations, credit bureaus calculate your credit by factoring in payment history, credit amounts, credit mix, and the overall age of your accounts. Replacing your original car loan with a brand-new loan reduces the average age of your credit accounts and will likely result in a very small dip in your credit.
- New debt. Similarly, taking on new debt will cause a temporary dip in your credit. However, since you are replacing an existing loan with a new one of the same amount at a lower interest rate, this effect is likely to be minimal.
Should You Refinance Your Car?
While it is true that your credit will briefly see a temporary impact when you apply for and receive an auto refinance loan, the positive benefits to your financial health often outweigh the implications.
For example, if refinancing your car will reduce your monthly expenses and help you pay your car note or other bills on time, the overall effect of refinancing will likely have a positive impact on your credit score in the future. If interest rates or your credit score have improved significantly, or if you’re having trouble making your monthly payments, refinancing is well worth the consideration. However, if you are close to paying off your car or are experiencing significant fees to refinance, the benefits may not outweigh the fees. In addition, if your car is more than seven years old or has more than 125,000 miles, most lenders will not consider a refi loan.
Is an auto refi loan right for you? First, you must consider your unique debt situation and credit history in order to get a feel for whether refinancing is worth the savings advantage. Remember, always make financial decisions with the help of a professional.