Does refinancing a car hurt your credit?

Refinancing a car loan could get you better loan terms and free up funds in your budget, but it may also hurt your credit score.

You’ll likely see a small drop in your credit score when you first refinance your auto loan. But don’t steer clear of it just because of a temporarily lowered score. Refinancing could be a sound decision that results in cost savings or much-needed financial relief.

How does refinancing affect your credit?

Refinancing a car loan can impact your credit score for a few reasons. A lender will need to do a hard inquiry to confirm you qualify, which is the primary reason you will see it fluctuate.

It can also decrease the average age of your accounts and act as a new account on your profile. Essentially, refinancing restarts your car loan. That can make it harder to qualify for other types of credit in the short term.

• It generates hard inquiries: Each time you apply for a loan, a hard credit inquiry is generated. This could result in a slight dip in your credit score. Hard inquiries remain on your credit report for up to two years but only impact your score for up to 12 months. Consequently, refinancing a car loan — which involves applying for a new loan — could temporarily ding your credit score.
• It lowers your accounts’ average age: Refinancing also lowers your average age of accounts, leading to a possible decrease in your credit score. The good news is account age only counts for 15 percent of your credit score under the FICO model. Your score should bounce back quickly if you responsibly manage your new auto loan and other debt accounts.
• It has more impact if reported as a new loan: If your loan refinance is reported as a “new” loan, it will more significantly impact your credit profile. The refinance will not only generate a credit inquiry but also have the added impact of creating a new “open date” on your profile. When a new open date shows up, it tells the credit agencies you have taken on a new debt obligation, increasing your overall debt load.

How long will my credit score be affected by refinancing?

Even though refinancing a car loan impacts your credit score, these effects are only temporary. Within a few months of uninterrupted, on-time payments, your credit score should return to where it was before you refinanced. In some cases, it may even increase slightly. If you have any hard inquiries related to your refinancing, these score impacts will fall off entirely within a year.

How to limit harm to your credit score

Although your credit score may drop when you refinance, there are ways to minimize the impact.

• Get prequalified: Shop around to find the best deal on refinancing. Once you have a shortlist of preferred lenders, apply for prequalification to view potential financing offers without affecting your credit score.
• Apply within a certain window: If you submit loan applications within a 14-day period, most credit scoring models will group them into a single inquiry. Depending on the credit scoring model, this window could go up to 45 days. This is called rate shopping and can also minimize the impact on your credit score.
• Pay on time each month: The most significant component of your credit score is your payment history. It accounts for 35 percent under the FICO model, so paying your loan on time each month will help your credit score bounce back.
• Wait to open additional credit accounts: Your credit age will decrease when you refinance. Holding off on opening new credit accounts after refinancing will help improve this number and possibly raise your credit score over time.
• Consider Experian Boost: This optional program means you can help boost your credit score by including payments on day-to-day bills like streaming services, rent and utilities. Experian Boost participants have a reported 13 points added to their FICO 8 credit score.

Is refinancing a good idea?

Most people pursue refinancing to save money, but the best time to refinance differs for each person. To get the most use out of refinancing your auto loan, you will need to qualify for a lower average rate or monthly payment — or both.

If average auto loan rates have dropped recently or you have improved your credit score, you could qualify for a lower rate. A lower interest rate will mean paying less overall. It may also lower your monthly payment, making it more affordable for your budget.

You can also opt to extend your loan term to lower your monthly payment, although this isn’t recommended. A longer loan term often means paying more interest and potentially becoming upside-down on your auto loan. And if you are close to paying off your auto loan, will face prepayment fees or have an older vehicle, it may be better to simply pay off the loan instead of refinancing.

The bottom line

The choice to refinance your car loan has benefits and drawbacks. Although it can temporarily hurt your credit score, the financial benefits may significantly outweigh the damage. There are also ways to minimize the impact on your credit score and help it rebound when you apply for refinancing.

Before deciding if refinancing makes sense, familiarize yourself with the process to avoid surprises. Also, explore refinancing lenders, get prequalified and run the numbers to make an informed decision.