Are you thinking about refinancing your auto loan, but unsure of what will happen to your credit score? Does refinancing hurt your credit? While credit scores can seem confusing and complicated, it is important to predict how certain financial moves will affect your credit history. Here we will discuss how credit scores are calculated and go over the impact of refinancing.
Auto Refinancing will cause a slight dip in your credit score, but it can still be worthwhile and might actually help your credit in the long run.
What is Auto Refinancing?
Auto refinancing is when you pay off your existing car loan with a new car loan. Your new loan will ideally have more favorable terms that will ultimately save you money (and who doesn’t want that?). To understand how vehicle refinancing will affect your credit, we will need to look at how credit scores are calculated.
How are Credit Scores Calculated?
Credit scores are used to help lenders assess how likely you are to pay back your debts. Credit agencies typically look at five factors to determine your credit score:
Payment History. This is the most important factor in calculating your credit score, accounting for 35% of your FICO score. Do you have a history of on time payments? Lenders want to be sure you will pay back your debt on time.
Amounts Owed. The amount of money you owe, your debts, are used to calculate your credit utilization score. This is the second most important factor in your credit score. This is calculated by dividing your total debt by your total credit limit.
For example:
Let's say, between all of your outstanding accounts, you currently owe $5,000.
Your combined credit limit for all of these accounts is $50,000.
5,000/ 50,000 = .1 = 10% Credit Utilization
A credit utilization score below 30% is considered desirable for lenders. This score accounts for 30% of your FICO score.
Credit History Length. The age of your credit accounts make up 15% of your FICO score. They look at the age of your oldest account, the age of your newest account, and the average age of all accounts. Having older accounts and a longer credit history is more favorable to lenders.
Credit Mix. Having a diverse assortment of accounts is beneficial to a high credit score. A healthy mix might include a mortgage, auto loan, student loan, and credit cards. This indicates to lenders that you can manage your money across multiple accounts. A healthy credit mix accounts for 10% of your credit score.
New Credit. The number of new accounts you have opened plus the amount of hard inquiries you have had on your credit account for 10% of your credit score. People often ask, “how long do hard inquiries stay on your credit?”. The answer is about one year. If you have had a significant amount of inquiries in this time period, it might be a red flag for lenders.
What is Considered a Good Credit Score?
Using the above factors, credit bureaus calculate a credit score for every person with a credit history. Credit scores typically range from 350 to 850.
800 to 850: Excellent credit
740 to 799: Very good credit
670 to 739: Good credit
580 to 669: Fair credit
300 to 579: Poor credit
People with the highest credit scores will more easily be approved for loans and credit applications, and will typically get the best interest rates and APRs.
How Will Vehicle Refinancing Affect Your Credit Score
Refinancing will affect two of the categories used to calculate your credit score: credit history length and new credit. Having a new account will negatively affect your credit history length, and the hard inquiries and new account will also affect the new credit category. BUT it is important to note that hard inquiries only last a year on your credit score, so that will only be a temporary ding. Credit bureaus know that people contact multiple lenders when looking to open an account, so they allow a two week timeframe where all inquiries will count as one hard inquiry. In other words, don’t let fear of lowering your credit score hold you back from shopping around for the best rates.
How to Prepare and Reduce Impact on Your Credit Score
To reduce the impact that vehicle refinancing will have on your credit, be sure to do your research and understand how credit scores are calculated. Complete all of your applications in a short period of time (under two weeks) so that all hard inquiries will count as one inquiry in the allotted window.
Is Refinancing Worth It?
This depends entirely on your situation, but it is often worthwhile to take a temporary hit on your credit score to improve your overall financial health. If you refinance and take a ding on your credit, the hard inquiry will only remain on your score for one year. The age of your accounts will also lengthen over time, so your credit history length will not be affected permanently. If refinancing makes it easier for you to keep up on your monthly payments, it may help your credit score in the long run. Should any of the following apply to you, it might be worth looking into refinancing:
Interest Rates are Going Down
If interest rates are trending downwards, it might be beneficial to refinance your car loan. Your overall savings will negate the temporary hit on your credit.
Your Credit Score has Increased
If your credit score has increased, you have a better chance of qualifying for a lower interest rate. Check your credit score at one or all of the three major credit agencies (Equifax, Experian, and TransUnion) and see how your current credit score compares to your score when you originally took out your auto loan.
You Need Extra Cash Every Month
If money is tight, refinancing might alleviate your monthly payments. If you are in danger of making late payments or defaulting on your loan, this will severely damage your credit score. It is far better to refinance and take a small hit than risk defaulting.
You Need to Add or Remove Someone as a Co-Borrower
If you need to either remove or add a co-borrower to your loan, refinancing will allow you to do so.
Your Car is Retaining Value
It is important that your car is retaining its value if you want to refinance. Owing more than the car is worth is called being “upside-down” in your loan. You will have a hard time finding a lender if this is your situation.
Whether or not it is worth it to refinance your car loan will depend on your situation, but the benefits of refinancing will often outweigh the dip that you might see on your credit score.
If you are wondering how to get approved for auto refinance, Auto Approve can help you compare quotes so you can start saving money today. Contact us today to get the ball rolling!