There are many reasons why someone might refinance their car.
Finding a better deal, needing more stability, or entering into a better financial situation is the most common.
However, just because you can refinance your car, doesn’t mean you should. We will explain all the details, and break down the process of car refinancing and answer the key question: does refinancing a car hurt your credit?
What Is Car Refinancing?
Car refinancing is when you switch or change your current financing contract. When you buy a car you can either purchase the vehicle out right, or you take out a loan.
These loans are called car finances, and they allow you to buy the car by paying for it monthly instead of all at once.
As with any loan, you will receive interest fees for the length of time you borrow money.
Refinancing is when you swap your current contract for a new one.
This normally means changing providers, but you can also refinance your car with your current provider but on a different contract.
The second contract “buys” the first contract, allowing you to move from one agreement to the next.
Why Refinance Your Car?
The most common reason to refinance your car is to get a cheaper deal. You may have started the contract with a poor credit score, and after a couple of years found yourself in a better financial situation.
With a better credit score, you could use a new provider with a cheaper APR or interest rate.
Others refinance their car to consolidate their loans as part of a new financial planning and management scheme by a financial advisor.
Instead of having multiple little loans, they take out one large loan which pays the little ones off. This is cheaper overall, as you won’t have to pay a flat fee from multiple lenders.
It also makes budgeting easier as you can see exactly how much you have left to pay, by looking at a single account.
Another reason to refinance your car could be due to financial issues.
If your income has lowered, and you cannot afford your current contract, you could reduce the monthly payments and increase the term or length of your agreement.
This is usually more expensive in the long run but allows you to keep your car.
Does Refinancing a Car Hurt your Credit?
Most people refinance due to payment changes. However before you agree to a new loan, you should consider how it affects your credit score.
Initial Decrease - Due To Hard Enquiry
Whenever you apply for credit, your credit score will automatically dip. This is because the lender will carry out a Hard Enquiry in the AU Market.
This enquiry allows the lenders to see your detailed credit history. However, it also lets other lenders know that you’re in need of money and are therefore a risk.
Requiring credit suggests you are in financial difficulty.
Because of this initial dip, you shouldn’t apply for more than one loan at a time.
Even if you’re attempting to gather comparative prices, allowing the lenders to create Hard Inquiries will create multiple dips in your credit score.
If a lender agrees to your refinancing plans, you can start paying off the loan as normal.
After a month or two of consistent payments (correct amounts and on time), your credit score will return to its previous figure.
Because of this, you shouldn’t be worried about the initial decrease. Instead, you should be aware of it, and restrain yourself from applying to too many lenders.
Initial Decrease - Due To Borrowing Amount
The amount you borrow will also affect your credit score.
Normally, your score will dip to reflect the new borrowing amount, however as you are refinancing you’re unlikely to borrow more than your previous agreement. This means the dip shouldn’t be big.
However, if you’re refinancing due to financial difficulties, and need to borrow a larger amount, you will see a large drop in your credit score.
Either way, the score will rise again in a month or two, as long as you stick to the payment plan.
Ability To Pay On Time
In your new contract, you will be told the recurring monthly payment plan.
This will include the day you need to pay before each month and the amount you need to pay. If you fail to make these payments correctly, your credit score will decrease and you will be fined.
This decrease will not go away after a month or two. Instead, it will stay on your credit history as a late payment and will remain there for 2 years.
This is the most significant impact your new loan will have on your credit report. However, the impact would be just the same on any loan. Late payments and underpayments have serious consequences.
How To Reduce Negative Impacts
The most important way to avoid negative marks on your credit report is to pay on time and pay the correct amount.
If you get this information wrong, you will be left with a 2-year permanent mark against your credit history.
Because you may forget about the loan, and therefore forget about making the payments, we recommend setting up a direct debit.
This way your bank will make the same payment on the same day every month, automatically. It’s a simple fix for a big problem.
The second way to reduce negative impacts is to only allow Soft Inquiries into your credit history until you are ready to settle with one lender. Soft Inquiries are usually free and quick.
They don’t look into the details of your credit history but can gauge enough information to give you an estimated interest rate.
Using that data, you can figure out the best deal on the market, and allow that lender to make a Hard Inquiry. With just one Hard Inquiry in process, your credit score will not dip dramatically.
Summary
So, does refinancing a car hurt your credit? The short answer is no, refinancing your car will not affect your credit score dramatically. You can expect a small dip at the beginning of the process, but the figure will return to normal after a month or two.
