Can Car Refinancing Improve Your Credit?

A car loan can represent a significant portion of your monthly budget. The amount that you pay in interest to buy a car, especially with a low down payment, can easily reach several thousand dollars over the life of the loan. This is why refinancing, which may depend on your credit score, can be a way to save money and protect your credit history.

What is Refinancing?

Car refinancing may seem to be a complicated process surrounded by confusing terms and numbers, but it is actually relatively simple. When you refinance a car, you get a new loan to pay off the balance on your existing car loan. Refinancing allows you to take advantage of lower interest rates or extend the term of your loan, each of which will lower your monthly payment.

Avoiding Default

The biggest way that refinancing a car helps your credit score is by reducing the risk that you'll default on your loan. Car loans have fixed interest rates that let you predict what they will cost each month, but a dip in your income or an unforeseen expense can make it difficult to pay bills on time and in full. If you fail to make your payments, your loan will go into default and you may incur late fees, penalties and, eventually, lose your car to repossession. Each of these events will hurt your credit score, so a monthly payment that you can make more easily serves to protect your credit.

Credit Score Significance

While car refinancing can help to preserve your credit, your credit score can also have an impact on how you refinance. Lenders save their best interest rates for borrowers with excellent credit. This means that if your credit improves as you pay off your auto loan, you may be eligible for a lower rate than the one offered when you were shopping for the car. In the future, if a lender sees that you chose to refinance, it will have a very small impact on your ability to borrow money. On the other hand, if you decide not to refinance and find yourself unable to make your payments, your credit score will start to drop immediately.

Downside

If you refinance your car with a loan that gives you more time to pay off the vehicle, you help protect your credit but risk paying more for the car in the end. Each month that you have the loan means more time for the lender to charge interest. A lower rate with a longer term might cost more than a loan with a higher interest rate that you can pay off sooner. While shopping for refinancing options, lenders will need to run credit checks as you apply. Each credit check appears on your credit report as an inquiry. Too many inquiries can harm your credit score, so only apply for refinancing once you've identified a good bargain and expect to accept the loan.