Refinancing an auto loan can save you money if your credit score has improved since purchasing the car. A higher credit score leads to a lower interest rate. Lowering an interest rate a point or two can mean more money in your wallet. Unlike refinancing a mortgage, the auto loan refinancing process is generally simple and inexpensive. Since you work hard to maintain a good credit rating, it is important to understand how refinancing will affect your score.
Shopping around for a lower interest rate will lower your score, even if you decide not to refinance. According to MyFICO, your score drops fewer than five points with each credit inquiry. Fortunately, credit bureaus lump together inquiries for the same type of credit. When you shop several different auto lenders to refinance, you will only be hit once instead of multiple times. If you are trying to refinance, limit searching to a 30-day window to keep the effect on your credit minimal.
Negative Credit Effect
When you refinance an auto loan, your credit score may experience some changes. Your current loan is closed and a new loan is then opened. Since newer accounts are not yet established, this can lower your score temporarily. Consumers who need to extend the terms of the loan to lower the monthly payment are also carrying the debt for a longer period. When it comes to credit, it is always best to pay debt off as soon as possible.
Boosting Your Score
Payment history is the largest determining factor of a credit score, accounting for 35 percent. Although inquiries and new loans can lower your credit score, timely payments can boost it back up within a few months. When you refinance the balance to a shorter term, you may be able to pay it off sooner, eventually reducing your debt to income ratio. Paying a larger down payment when you refinance can also help keep your score from dropping.
If you are in the market for a new mortgage or other secured line of credit, you may want to postpone refinancing. Instead, you may want to discuss a rate modification with your current lender. A rate modification is used to grant borrowers in good standing a lower interest rate without the refinancing process. For those who don't plan on making any big purchases in the near future, the minor credit effect should not be enough to keep you from refinancing.