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Refinancing an auto loan likely will temporarily lower your credit score, but that's a small price to pay if the new loan saves you money or helps you avoid car payments you can no longer afford. Here's what you need to know.
How Does Refinancing an Auto Loan Work?
To refinance a car loan, you'll use a new loan to pay off what's left on your current car loan, ideally securing yourself a lower interest rate or lower monthly payment in the process.
The process of finding this new loan will go much the same way it did when you initially financed the car, meaning you'll be able to apply to multiple lenders and compare interest rates and fees to find the loan with the best terms.
Once you accept a loan offer, the refinancing lender sends a payment for the remaining balance on your loan to the lender that originally issued it. The new lender then takes over the lien on the car (the legal right to take possession of the car if you fail to make your payments). You'll make monthly payments to the refinance lender until you've paid off the new loan.
When deciding whether to refinance your car, and which lender to refinance with, you should focus on one or both of these objectives:
- Save on interest. Refinancing can reduce the total amount you'll pay for your car if your new loan has a lower interest rate. Since auto loans can be for tens of thousands of dollars, even a 1 percentage point difference can net you significant savings over the life of your loan.
Remember, though, that any fees the lender charges to issue the new loan (origination fees) will reduce those savings. You also may not benefit from a refinance much or at all if you don't have much left to pay on your loan. Before refinancing, make sure you'll actually save money by calculating your interest savings and comparing it the total costs of each loan, taking fees into account. - Reduce your monthly payment. If household expenses have increased since you took out your car loan, or if you'd just like a little more breathing room in your monthly budget, you can use refinancing to lower your monthly payments. This typically entails getting a new loan that extends your original payback period by six months or more. You'll likely end up paying more in interest, but by spreading out your repayment, you're reducing how much you need to pay every month. Refinancing to reduce your payment may be worthwhile if it helps you avoid missing a car payment or any of your other bill payments.
Refinancing a Car Can Temporarily Lower Your Credit Score
Auto refinancing, just like any type of refinancing, has the potential to affect your credit scores as calculated by the FICO® Score☉ and VantageScore® scoring models. When you apply for loans to shop for the best rate, each lender you apply with will request a credit check that causes a hard inquiry to be entered on your credit report. This typically causes a small reduction in your credit score. If you qualify for and accept a loan offer, you'll typically see another small score dip.
The reason for both these score reductions is similar: When borrowers first apply for and take on new debt, they are statistically at greater risk of missing their bill payments. A few months of uninterrupted payments is all that's typically needed for your credit to return to their former levels—or even increase slightly.
Two considerations to keep in mind:
- If you're shopping around for a loan, multiple hard inquiries will not do cumulative harm to your credit score. The FICO® Score and VantageScore systems are designed to encourage loan shopping and consider applications made within a span of a few weeks as a single event as far as your score is concerned. The score impact of hard inquiries will fall off entirely within a year.
- Taking on new debt typically causes your credit score to dip, but because refinancing replaces an existing loan with another of roughly the same amount, its impact on your credit score is minimal.
When refinancing is finalized, your new loan will appear on your credit report, and your payments toward it will be tracked. Your original car loan will remain on your credit report as well, marked "closed in good standing," for up to a decade.
When Is It a Good Idea to Refinance a Car Loan?
It makes sense to refinance a car loan under the following circumstances:
- Your car is holding its resale value. Before applying to refinance your auto loan, check valuations from Kelley Blue Book, Edmunds.com or the National Association of Auto Dealers to determine your car's approximate resale value. If your car is worth less than what you owe on it due to age, mileage crashes or other issues, refinancing may prove difficult.
- Interest rates are dropping fast. If changing economic conditions have significantly brought down the cost of borrowing, you may qualify for a new loan at a lower rate. The average interest rates on a new car loan in the U.S. was 5.76% in the fourth quarter of 2019, according to Experian data—down from the prior year. With Fed rates slashed to near-zero in 2020, it's possible you'll continue to see a greater difference in your new interest rate as time goes on.
- Your credit score is higher. If you increase your credit score significantly in the 12 months or so after taking out a car loan, you may qualify for loan offers with better interest rates. (When combined with overall interest rate declines, this could rack you up some appreciable savings.)
- You need to cut expenses. Extending your car loan repayment period may make sense if you need to reduce monthly expenses, even if it means paying more over the course of the new loan.
When Is It a Bad Idea to Refinance a Car Loan?
An auto loan refinance can be a smart way to save money, but there are several circumstances in which it may not make sense:
- If interest rates have increased since you took out your original car loan, it may be impossible to get a better financing rate, even if your credit scores have also improved in the interim. (As noted above, this has not been a big concern in recent years, but circumstances can always change.)
- If you've paid off the majority of your car loan, the benefits of refinancing may be negligible, as origination fees on the new loan could offset the savings you'd get by refinancing just 12 to 18 months of payments. (If you're in expense-cutting mode, the need to stretch out your payment term and lower payments could overrule this consideration.)
- If you purchased your car new or near new and have since logged exceptionally high mileage, or if it's been damaged in a crash, flood or other mishap that'll significantly reduce its resale value, you may not be able to get a loan that covers what you owe on the original loan.
Finally, a strategic consideration: If you're planning to seek a mortgage or other large loan in the next six to 12 months, it's wise to refrain from applying for any credit, including auto refinancing, that could cause a dip in your credit score. Avoiding new credit applications can help you present your best possible credit score when you submit your mortgage application.
Can You Refinance an Auto Loan With Bad Credit?
If your credit scores have dropped significantly since you took out your original car loan, it may be difficult to find refinancing that saves you money because lenders typically charge higher interest rates to applicants with lower credit scores. If your refinancing goal is lower monthly payments, however, you may be able to find an auto lender that specializes in borrowers with less-than-ideal credit. You may qualify for a new loan with a longer repayment period that'll cost more over time than the original loan did, but the extra expense could be worth it if it means you can pay today's bills more easily.
If you're at risk of missing a payment on your original car loan and having difficulty finding refinancing options, reach out to your lender as quickly as possible to explain the situation. While they are not obligated to do so, some lenders will work with you and may even modify your original loan terms to give you lower payments—in exchange for a higher interest rate and potential fees.
Getting Your Credit in Shape for Auto Refinancing
When seeking auto refinancing or applying for any credit or loan, it's wise to review your credit reports and check your credit score to know where you stand as an applicant. You can get a free credit report from all three consumer credit bureaus (Experian, TransUnion and Equifax) by visiting AnnualCreditReport.com. You can also get a free copy of your Experian credit report every day.
As you research your loan options, you can also take steps to increase your credit score quickly, with the best tactics for fast improvement being:
- Paying down high credit card balances, ideally getting all balances down to 30% or less of the cards' borrowing limits.
- Consider enrolling in Experian Boost®ø, which applies your record of cellphone, cable and other utility payments to your Experian credit report and can help increase FICO® Scores based on Experian data.
- Continuing to make all your debt payments on time.
Refinancing a car can save you money over the long term, reduce your monthly payments (or both!) to ease your household budget. Experian partner RateGenius can help you better understand your auto loan refinance options. Shop around for lenders and do your best to put forward the best credit scores you can get, and you could drive home a great deal.