You’ve been paying your auto loan diligently for years, but interest rates have dropped significantly since you first financed your vehicle. Refinancing your auto loan could lower your payments and save you money in the long run. However, you may be concerned about how refinancing impacts your credit. The good news is, refinancing an auto loan typically helps your credit if done properly. It helps your score in some cases.
By understanding how auto loan refinancing works and following a few best practices, you can lower your interest rate and monthly payment without damaging your credit. In this article, we will explore how auto loan refinancing impacts your credit score, steps you can take to minimize any negative effects, and strategies to ensure you get the best new rate on your refinanced loan. You can lower your vehicle payment and maintain your hard-earned good credit with the right approach.
How Car Refinancing Affects Your Credit Score
Refinancing your auto loan has a direct impact on your credit score. When you apply for a refinance, the lender will check your credit, which results in a hard inquiry. Too many hard inquiries in a short period can hurt your score. However, if done strategically, refinancing can help your credit.
To minimize damage, research to find lenders likely to approve you before applying. This avoids multiple hard inquiries from lenders denying your application. Check your score and credit report to ensure no errors before applying. Dispute any errors to get your best score.
Once approved, refinancing can improve your credit utilization ratio, which accounts for 30% of your score. If you lower your interest rate, more of your payment goes toward the principal, reducing your balance faster. A lower balance relative to your limit helps your score.
Refinancing may lengthen your loan term, reducing your payment. While tempting, avoid extending too long, or you’ll end up paying more interest over the life of the loan. A reasonable extension of 1-2 years can make payments more affordable without excessively impacting your total cost.
If done strategically by checking your score, minimizing hard inquiries, reducing your balance, and not overly extending the term, refinancing your auto loan need not damage your credit and can provide a boost. With an improved score, you’ll qualify for better rates and terms on future loans. Ultimately, that’s the real benefit of maintaining a good credit score.
When Refinancing Makes Sense to Get Cash for Cars
Refinancing your auto loan can be smart if the numbers make sense for your situation. When interest rates drop significantly from when you first financed your vehicle, refinancing allows you to take advantage of lower rates and potentially lower your monthly payment. However, refinancing does require another hard inquiry on your credit report and may lower your average account age if done less frequently.
You should consider refinancing your auto loan if:
- Interest rates have decreased by at least 2 percentage points since you obtained your original loan. This can translate into hundreds of dollars in interest savings over the life of the loan.
- You have improved your credit score. A higher score may qualify you for a lower interest rate, allowing you to refinance at a lower rate.
- You want to lower your monthly payment. Refinancing at a lower interest rate and extending the loan term can decrease your payment amount. However, you will end up paying more interest over the life of the loan.
- You want to cash out. If your vehicle has equity, you can refinance for more than you owe and take the difference in cash. You must ensure the new loan balance does not exceed your vehicle’s value.
While refinancing an auto loan makes sense in some situations, it does require a hard credit check and may lower your average account age. However, as long as you don’t refinance too frequently, the impact on your credit should be minor. The savings and benefits of a lower interest rate and payment often outweigh the small credit effect, especially if rates have substantially decreased since purchasing your vehicle.
Strategies to Minimize the Impact of Auto Refinancing on Your Credit
To minimize the impact of refinancing your auto loan on your credit, there are a few key strategies you can employ:
- Check your credit score and credit report first. Review your credit report to understand your current scores and check for errors. Dispute them if found. The higher your scores, the better position you’ll be in to qualify for a good new interest rate.
- Shop around at several lenders. Apply for preapproval at a few places to compare offers. Only official applications, called “hard inquiries,” can temporarily lower your score by a few points. Limit applications to around 3 lenders.
- Choose a shorter loan term. If your budget allows, opt for a shorter term, like 36 or 48 months. This may mean a slightly higher payment, but you’ll pay less interest over the life of the loan and be able to qualify for a lower rate. Shorter terms also look more favorable to lenders.
- Make a larger downpayment. Putting down at least 20% of the vehicle’s value demonstrates your financial responsibility to lenders and can help offset any minor credit impacts from applying for the new loan. The more you put down, the less you need to borrow.
- Keep existing credit accounts open. Don’t close any credit cards or other accounts in an effort to raise your scores quickly. Your credit history length and credit utilization ratio matter. Keep accounts open and continue using them responsibly.
- Check your new scores. About 6 to 12 months after refinancing, check your credit reports and scores again. Your scores may have dropped slightly from the inquiries but should start to rebound as you continue making on-time payments. Take action if you notice any fraudulent activity.
With some preparation and patience, you can refinance your auto loan without causing significant or long-term damage to your credit. Focusing on the strategies above will help ensure the best outcome for your needs and financial well-being.
Conclusion
While lowering your interest rate and monthly payment sounds appealing, you want to ensure short-term gains don’t damage your credit in the long run. By choosing a reputable lender, maintaining consistent payments, and avoiding excessive “rate shopping,” you can refinance strategically and responsibly. Keep your eye on the big picture – establishing a good payment history and strong credit. If done right, refinancing your auto loan can be an opportunity to improve your financial well-being for years to come. The keys are going in with a plan, asking the right questions, and making payments on time. With prudent management of your refinance, you’ll be cruising down the road of financial freedom.
