Does Refinancing a Car Hurt Your Credit?

Refinancing a car loan can be a strategic financial decision, often pursued to secure a lower interest rate or reduce monthly payments. Many individuals contemplating this step frequently wonder about its potential impact on their credit scores. While it involves actions that affect credit, understanding these helps make an informed choice about whether refinancing aligns with your financial objectives.

The Credit Inquiry

Applying to refinance a car loan typically triggers a “hard inquiry” on your credit report. Lenders access your credit file to assess creditworthiness for a new line of credit. Hard inquiries differ from “soft inquiries,” which do not impact your score.

A hard inquiry can cause a slight, usually temporary, dip in your credit score, often by under five points. These inquiries remain on your credit report for up to two years, though their effect on your score diminishes significantly after the first 12 months. When shopping for an auto loan refinance, multiple inquiries within a short period, generally 14 to 45 days, are often treated as a single inquiry by credit scoring models, minimizing the collective impact on your score.

Impact on Account History

Refinancing an auto loan means paying off your existing loan and opening a new one. This affects two aspects of your credit history: the average age of accounts and your credit mix. While the old loan account is closed, its positive payment history remains on your credit report for a substantial period, often up to 10 years, continuing to contribute to your overall credit history.

Opening a new loan can slightly reduce the average age of all your open credit accounts, as a newer account lowers the overall average. However, this factor, length of credit history, constitutes about 15% of a FICO score and is considered less influential by some other scoring models. Introducing a new auto loan can modestly alter your credit mix, which refers to the variety of credit types on your report (e.g., installment loans, revolving credit). A diverse credit mix can be seen favorably by lenders, though it accounts for a smaller portion, around 10%, of your FICO score.

Credit Score Factors and New Loan Terms

Terms of a refinanced car loan can influence credit score components, particularly the “amounts owed” category. While credit utilization primarily refers to revolving credit like credit cards, the principal balance of an installment loan, like a car loan, is also considered. A new loan with a lower principal or more favorable terms might be viewed positively, especially if it replaces a higher balance loan.

Debt-to-income (DTI) ratio is a consideration for lenders, though it does not directly impact your credit score. Income is not a factor in credit scoring models, so DTI is not included in your score calculation. A change in your monthly car payment from refinancing, either lower or higher, directly affects your DTI. Lenders use DTI to evaluate your capacity to manage debt; a lower DTI indicates greater financial health.

Refinancing and Improved Payment Behavior

While immediate refinancing effects include a small, temporary credit score dip from hard inquiries and account changes, long-term impact is largely determined by payment behavior on the new loan. Payment history is the most significant factor in credit scoring, accounting for 35% of a FICO score and highly influential in other models like VantageScore. Consistently making on-time payments demonstrates responsible credit management.

Refinancing to achieve a more affordable monthly payment can enhance a borrower’s ability to make consistent, timely payments. This improved payment behavior contributes positively to credit history over time, helping rebuild any minor score reductions from refinancing. The most lasting positive influence on a credit score comes from a reliable record of on-time payments, which can outweigh short-term effects of applying for new credit.