Does Refinancing a Car Hurt Your Credit?
Understand how refinancing your car loan can influence your credit score, from the initial inquiry to managing your new payments.
Refinancing a car loan involves replacing an existing auto loan with a new one, often to secure different terms. This process can influence an individual’s credit score, and understanding these effects is important for making informed financial decisions.
Understanding Car Refinancing
Car refinancing involves obtaining a new loan to pay off an existing auto loan. This new loan typically comes with different terms, which can include a modified interest rate, a new loan duration, or an adjusted monthly payment. Common reasons for refinancing include securing a lower interest rate to reduce total interest paid, lowering monthly payments for financial flexibility, or changing the loan term to pay off the vehicle faster or slower.
How Refinancing Impacts Your Credit Score
Refinancing a car loan influences a credit score through several mechanisms. Each aspect contributes to how the credit bureaus assess financial behavior and risk.
When applying for a new loan, a “hard inquiry” occurs, where the potential lender requests a full credit report. This inquiry typically causes a slight, temporary dip in a credit score, usually by fewer than five points. Hard inquiries can remain on a credit report for up to two years, though their impact on a FICO score often diminishes after 12 months. Multiple inquiries within a short period for auto loans are generally treated as a single inquiry by credit scoring models, allowing for rate shopping without multiple score reductions.
Opening a new loan account also affects the “average age of accounts” and “credit mix” components of a credit score. A new account can initially lower the average age of all credit accounts, which is a factor in credit scoring models. However, establishing a new installment loan can positively contribute to the credit mix, particularly if a borrower’s credit profile was previously dominated by revolving credit, demonstrating the ability to manage different types of debt.
The most significant factor influencing a credit score is payment history. Consistent, timely payments on the new, refinanced loan are crucial for building and maintaining a strong credit score. Conversely, missed or late payments can severely damage a credit score, potentially causing a significant drop. Maintaining an excellent payment record on the new loan helps demonstrate responsible credit management over time.
A potentially lower principal balance or reduced monthly payment achieved through refinancing can also affect the “amounts owed” or “credit utilization” aspect of a score. By potentially reducing the overall reported debt burden, especially if the new loan has more favorable terms, this can positively influence the credit score over time. This reduction reflects a lower proportion of available credit being used, which is generally viewed favorably by credit scoring models.
Preparing for a Refinance Application
Gathering specific information and documents streamlines the car refinance application process. Having these items organized beforehand helps ensure a smoother and more efficient application experience.
Personal information required typically includes a driver’s license, contact details, employment history, and proof of income. Income verification can involve recent pay stubs, W-2 forms, or tax returns, depending on the employment type. Lenders use this information to assess a borrower’s ability to repay the new loan.
Details about the current loan are also necessary. This includes the original loan amount, the current outstanding balance, the existing interest rate, and the name of the original lender. Providing the loan account number and recent loan statements is also common practice.
Information about the vehicle itself is another important component. This typically covers the car’s make, model, year, Vehicle Identification Number (VIN), and current mileage. Proof of auto insurance, often including specific coverage details and listing the new lender as a lienholder, is also commonly requested.
The Refinancing Application Process
The refinancing application process begins with finding a suitable lender. Borrowers can explore options from various financial institutions, including traditional banks, credit unions, and online lenders. Comparing offers from multiple sources can help identify the most favorable terms for a new loan.
After selecting a potential lender, the application is submitted, often through an online portal, in-person at a branch, or via mail. This submission includes all the previously gathered personal, financial, and vehicle information. The lender then proceeds with a review and approval process, which involves verifying the submitted information and performing a credit check.
Upon approval, the new loan is finalized, typically involving the signing of new loan agreements. A crucial step involves the new lender paying off the existing car loan. Borrowers should continue making payments on their original loan until confirmation is received that the old loan has been fully paid off.
After the old loan is settled, the vehicle title is transferred to reflect the new lender as the lienholder. This transfer process can take several weeks, depending on the state’s Department of Motor Vehicles (DMV) procedures. Following these steps, borrowers begin making payments on their new refinanced loan and should monitor their new loan account to ensure accuracy.