How Does Refinancing a Car Loan Affect Credit score

How Does Refinancing a Car Loan Affect Credit? 3 Key Factors to Consider

You’ve figured out that refinancing your car may save you a significant amount of money. Great news! The next question most people want to know is how it will affect their credit score.

The answer will often determine whether or not refinancing is the best option for you. So, let’s look more closely at the potential consequences.

How does refinancing a car loan affect credit? Is it a bad idea to refinance your car?

What happens when you refinance your car loan? You will be getting a new installment loan, which pays off your old loan. The old loan account will be closed and marked “paid in full.” You will then make your payments to your new lender.

Here are three factors that can potentially cause your credit score to drop during the process.

1. Rate shopping the wrong way

First, you will need to find a new lender that offers you a better deal than your current one. At this stage, your actions can potentially hurt your credit score. Here is why.

“Each of the hard inquiries on your credit record will reduce your credit score by three to five points.”

When a legitimate business checks your credit, it is referred to as an inquiry. There are two types of inquiries. The first is a hard inquiry. This occurs when a borrower applies with a lender to get approved for a line of credit or a loan.

The potential lender is reviewing your credit to decide if they should lend to you or not. This inquiry type hurts your credit score, according to MyFICO. Robin Williams, Executive at Cash One, says, “Each of the hard inquiries on your credit record will reduce your credit score by three to five points.”

There is an exception to this, though. When a person is “rate shopping” for a mortgage, student loan, or auto loan, all hard inquiries within a 45-day period count as one. However, if any inquiries are outside of the 45-day period, they will have a negative impact.

Soft inquiries are the other type of inquiry, and they have no impact on your credit score. These occur when a prospective lender is not technically reviewing you.

For example, it’s when YOU check your credit or when businesses check your credit to offer you promotional offers. More and more lenders are enabling customers to get prequalified using soft inquiries, such as Prosper and LightStream.

So, how you rate shop for a refinancing lender will influence whether or not you negatively impact your credit score. That’s why SuperMoney built this auto loan offer engine.

It will provide you with offers from multiple lenders using soft inquiries, all in one place. Taking this route will eliminate the worry negatively impacting your credit score.

2. Decreasing the average age of your accounts

Another factor in your credit score is the average age of all of your accounts. This category makes up about 15% of your overall score. The longer the average, the better.

When your new creditor buys out your old loan, the average age of your accounts in your credit report will often decrease, thereby potentially negatively affecting your credit score.”

You can calculate it by dividing the number of accounts you have by the total amount of months they have been open. Some credit scoring models will not count closed accounts toward your average, while others may weigh them less heavily than open accounts.

“When your new creditor buys out your old loan, the average age of your accounts in your credit report will often decrease, thereby potentially negatively affecting your credit score,” says Williams. The impact of the closed loan on this credit score factor will depend on your other loans and their lengths.

The more established your credit history, the smaller the impact. It will take time for the new loan to age and begin to help this credit score factor. But, it will in time.

3. Too many new accounts

The “New Credit” category might also impact your credit score when refinancing. It accounts for 10% of your score and looks at the number of accounts opened in a recent period.

Often, the benefits of the refinance will outweigh the credit score impact. Williams says, “Even in the worst case scenario, it’s not so damaging a situation because paying back your new loan on time will again recover your credit score in the long run.”

Too many accounts opened in a short amount of time can hurt your score. Just refinancing alone will be okay. However, if you have recently opened several credit cards or other lines of credit, you may lose some points in this category.

To refinance or not to refinance?

As you can see, refinancing a car loan can potentially hurt your credit score, but it doesn’t have to. By shopping smart and refraining from opening other credit accounts around the same period, you can minimize the impact.

And, the more established your credit, the less impact it will have.

Often, the benefits of the refinance will outweigh the credit score impact. Williams says, “Even in the worst case scenario, it’s not so damaging a situation because paying back your new loan on time will again recover your credit score in the long run.”

To get started on the right foot, research a number of auto lenders here and find out what rates you qualify for without hurting your credit score.

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