If you’re one of the 100 million-plus Americans with an auto loan, you might be looking for ways to make that loan more affordable. Whether it’s securing a better interest rate or lowering your monthly payments, refinancing could be the answer.
Refinancing a car loan means taking out a new loan with (hopefully) better terms and using the proceeds to pay off your existing loan. It’s a common practice — but it doesn’t make financial sense for everyone, particularly if you can’t get a lower interest rate. So if you think car loan refinancing might be right for you, here’s what you should know before you apply.
7 steps to refinancing a car loan
The process for car loan refinancing can vary by lender, but here are the general steps you’ll follow:
1. Review your current auto loan
2. Estimate the value of your car
3. Check your credit score
4. Gather the necessary documents
5. Compare lenders and get preapproved
6. Apply for an auto refinance loan
7. Pay off your original loan and make payments on your new loan
1. Review your current auto loan
Before you get too deep into the refinancing process, evaluate whether refinancing makes the most financial sense.
Find your current loan contract and review key details — particularly your current annual percentage rate (APR), repayment term and monthly payment amount. Compare these numbers to the refinancing offers you receive.
Also, check for any prepayment penalties. If the fee for paying off your car loan early is steep, it may outweigh any financial benefits gained from refinancing. Prepayment penalties commonly cost 2% of the remaining loan balance. So if your auto loan has $30,000 remaining, you may pay a $600 penalty for repaying it early — eating into your savings.
You should also log on to your lender’s online portal and determine your payoff amount and how many months are left on the loan. (If this information isn’t available online, you can contact the lender directly and ask.) It may make more sense to continue paying down your existing loan if you’re near the end of the term and don’t have much left on the balance.
2. Estimate the value of your car
Next, approximate the current market value of your car. You can rely on industry guides like Kelley Blue Book or Edmunds, as well as retailers like CarMax and Autotrader. Get a few free estimates to better understand what your car is worth, as each organization may calculate your car value a bit differently.
Importantly, make sure your auto loan isn’t upside down (or underwater), according to Shinobu Hindert, a certified financial planner based in southern California.
“If your loan is upside down, that means you owe more on your loan than your car is currently worth,” she said. “If this is the case, refinancing can be tough and maybe not possible if you don’t have great credit.”
3. Check your credit score
Your credit score impacts your ability to refinance an auto loan and the rates and terms lenders offer. There are many websites that let you see your score for free, though it’s usually your VantageScore.
Most major lenders consider your FICO score, which may be different from your VantageScore. Check with your current bank and credit card issuers to find out if they provide free FICO scores to customers, or you find it for a fee through various third-party services.
If your credit score is higher now than when you first borrowed your car loan, you may be eligible for a lower interest rate.
4. Gather the necessary documents
Getting your verification documents in order before you apply can streamline the process. Typically, you’ll need to provide:
- Proof of income, such as recent pay stubs and tax returns
- Proof of residency, such as a mortgage statement or lease agreement
- Details about your vehicle, including the VIN, make, model, year and mileage
- Proof of insurance
- Information about your current loan, including your interest rate, loan balance, remaining loan term and account number
- Personal identification, such as a driver’s license or passport
5. Compare lenders and get preapproved
Not all lenders offer the same refinancing terms, so it’s crucial to shop around. Receiving multiple offers can help you select the loan with the lowest interest rate.
“You can shop new lenders and then call your existing lender to let them know you’ve been offered a lower rate elsewhere,” Hindert said. “Your existing lender may match the outside offer and lower your interest rate to keep your business.”
However, if you bought your car with dealer-arranged financing, Hindert said you’re likely to find better offers from a credit union or community bank, especially if you already have an account with them. Check out online lenders as well; due to the low overhead costs of exclusively providing loans online, these companies often feature lower rates and better terms than brick-and-mortar institutions.
You can get preapproved online with most lenders by providing a few key details and agreeing to a hard credit inquiry. Preapproval gives you a firm idea of the rates and terms you may receive so you can easily compare offers. With that said, hard credit inquiries can negatively (albeit temporarily) ding your credit score, so it’s best to file your preapproval applications within a 14-day window — the credit bureaus will count similar inquiries made in that timeframe as a single hard pull to allow for rate shopping.
6. Apply for an auto refinance loan
When you’ve chosen the best offer, submit an official application for refinancing. Completing the application should take less than an hour, especially if you’ve already gathered the necessary documents.
The lender will verify your information and extend an official loan offer if you’re eligible. Look closely at the APR, monthly payment and loan duration, and ensure that the new loan aligns with your financial goals.
7. Pay off your original loan and make payments on your new loan
If you’re approved and satisfied with the loan terms, the final step is to close on the new loan. This typically involves signing a new loan agreement and setting up payment details. The new lender may pay off your old loan directly or provide you with the funds to pay it yourself.
Be sure you know when your first payment is due with the new lender and adjust your budget accordingly. You may want to sign up for automatic payments to ensure you never miss a due date. As an added bonus, many lenders offer small autopay interest rate reductions, commonly worth 0.25 percentage points.
Pros and cons of refinancing your car loan
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One of the biggest benefits of refinancing a car loan is that it can help you save money, whether you’re looking to pay less on a monthly basis, spend less on interest over time or both. If you qualify, you might also secure more favorable terms beyond the interest rate, such as a shorter loan term.
On the other hand, refinancing could end up costing you if you aren’t careful. A longer term could mean paying much more interest over the life of the loan. Plus, some lenders charge fees that could wipe out any savings you would enjoy. Refinancing can also have a negative impact on your credit in the short term, though making on-time loan payments will help your credit in the long run.
When is refinancing a car loan a good idea?
If your credit score has improved
If your financial situation has improved since you first took out your auto loan, you might be eligible for better loan terms. For example, you may have spent the past few years improving your credit score, and it’s now much higher than when you applied for your first loan. You may have also increased your income, which can help you qualify for better terms as well.
There’s another perk of refinancing with improved credit: If you borrowed your original loan with a cosigner, you may be able to refinance to a loan in your name only. This allows you to assume full responsibility for repayment and take the burden off the other person.
If interest rates have dropped
One of the most common reasons for refinancing a car loan is to take advantage of lower interest rates. If rates have declined since you first took out your loan, you might qualify for a better rate on a refinance loan. Lower rates equate to a lower overall cost of borrowing.
Good to know: Remember that if you extend the length of the repayment term, you’ll pay interest for a longer period, possibly canceling out any savings from the lower rate. So if possible, keep the term the same — or if your budget allows, shorten it for even greater savings.
If you didn’t shop around for your original loan
Maybe you were a little too excited about buying your first car, or you financed the purchase through the dealership without getting other offers. If you didn’t do much comparison shopping before financing your car purchase, you may have agreed to a less-than-ideal loan. By taking the time to compare lenders and offers now, you may be able to take advantage of a better deal.
If your monthly payments are too high
If your budget is strained and you’re looking for ways to increase your monthly cash flow, refinancing could be the solution. By lowering your interest rate or extending your term, you could lower your monthly loan payments. Again, remember that extending your repayment timeline could cost you more in the long run.
Frequently asked questions (FAQs)
Refinancing involves taking out a new loan and using the proceeds to pay off your existing loan. Some refinance lenders will handle the payoff process on your behalf, while others will deposit the funds into your account so you can pay it off directly.
Refinancing a car loan with bad credit is difficult, but not impossible. You may be eligible if you apply with a qualified cosigner. Otherwise, you’ll likely receive high interest rates and fees, meaning refinancing probably isn’t worth it. You might be better off taking time to improve your credit score before shopping around again.
Refinancing your car loan will likely impact your credit score in a couple of ways. When you seek preapproval or submit a formal application, the lender performs a hard credit inquiry, which may cause your score to drop by a couple of points. Taking on a new loan also increases the total amount of debt you owe, which can cause your score to fall.
However, if you consistently make your payments on time, having an installment loan in good standing on your credit reports will help your score in the long run.
The time it takes to complete the car loan refinancing process varies by lender. Some lenders process and approve applications same-day, while others may take one to two weeks.
