Refinancing a car loan is the process of replacing your existing auto loan with a new loan, often from a different lender. It allows you to change the terms of the loan, such as the interest rate, loan amount or repayment period. Refinancing can potentially help you lower your monthly payments, pay off your car faster or access your car’s equity. However, it also comes with some drawbacks to consider.
Why Refinance a Car Loan?
There are several reasons why refinancing your auto loan could make good financial sense
Lower Interest Rate
The most common motivation for refinancing a car loan is to get a lower interest rate. If your credit score has improved significantly since you first got the loan, you may now qualify for better rates from other lenders. Even a small reduction of 1-2% in the rate can add up to hundreds or thousands of dollars in interest savings over the life of the loan.
Lower Monthly Payments
Extending the repayment term when you refinance can drastically reduce your monthly payments. This improves cash flow in the short term, though you’ll likely pay more interest over the full loan period. It can be a good option if money is tight.
Pay Off Loan Faster
On the flip side, shortening the term when you refinance lets you pay off the loan faster. Your monthly payments will be higher but you’ll save on interest and own your car sooner. This works well if your income has increased.
Tap Your Car’s Equity
With a cash-out refinance, you can access your car’s equity by borrowing more than what you currently owe This gives you extra cash, though it increases the loan amount Use equity carefully as you don’t want to end up owing more than the car’s value.
Change Lenders
Maybe you want to move away from your current lender due to poor customer service or prepayment penalties. Refinancing allows you to start fresh with a new lender.
How Does Refinancing a Car Loan Work?
Refinancing an auto loan involves a few key steps:
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Review your current loan terms – Note details like the interest rate, remaining balance, monthly payments and repayment end date. This gives you a baseline for comparison.
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Check your credit – Good credit scores in the 690+ range will get you the best refinance rates. Boost your score if needed before applying.
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Research new lenders – Compare offers from banks, credit unions and online lenders. Get pre-qualified to see estimated rates.
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Apply for the refinance loan – Submit a loan application with your chosen lender. You’ll need documents like proof of income and insurance.
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Get approved – The lender will verify your application details and run your credit check. This determines the exact loan terms.
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Close on the new loan – After approval, you’ll sign the final paperwork. The lender pays off your old auto loan and puts the new loan in place.
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Update registration – Contact the DMV to update vehicle registration into the new lender’s name. Account numbers change after refinancing.
The process takes about 2-3 weeks from application to closing the new loan. There is some paperwork involved but lenders handle most of the heavy lifting.
Pros of Refinancing a Car Loan
Refinancing an auto loan can offer many benefits:
Lower Interest Rate
As explained earlier, even a small rate reduction results in substantial interest savings over the loan term. Run the numbers to see how much you can potentially save with a lower rate.
Lower Monthly Payments
Extending your repayment period lowers the monthly payment by spreading costs over more months. This improves short-term cash flow.
Pay Off Loan Faster
Shortening your term when refinancing allows you to own your vehicle sooner. You’ll save on total interest paid too.
Access Equity
Tapping into your car’s equity through a cash-out refinance gives you extra money to use for other financial goals.
Better Loan Terms
Switching lenders could get you better terms like no prepayment penalties, more flexible payment options and better customer service.
Improve Credit Score
Responsibly managing a refinanced loan can further boost your credit score over time. This saves you money on future loans and credit costs.
Cons of Refinancing a Car Loan
However, there are also some potential disadvantages with refinancing to think about:
Fees and Closing Costs
You may have to pay fees to your old and new lender. This includes origination fees, application fees and state registration costs. Factor these into savings calculations.
No Guaranteed Savings
A lower monthly payment doesn’t always mean total interest savings – it depends on the new loan’s term and rate. Do the math carefully.
Risk of Upside Down Loan
If you borrow more than the car’s value when refinancing, you’ll owe more than it’s worth. This puts you at risk of negative equity.
Prepayment Penalties
Your existing lender may hit you with fees for paying off the loan early. Ask about prepayment policies before refinancing.
Credit Inquiries
Too many loan applications in a short span can negatively impact your credit score. Be selective about which refinance offers to apply for.
Hassle Factor
It takes time and effort to apply, close and switch over the loan. Determine if the savings outweigh the hassle.
When Does Refinancing a Car Loan Make Sense?
As a rule of thumb, refinancing your auto loan is smart if you can:
- Lower the interest rate by 2% or more
- Reduce monthly payments by at least $100
- Pay off the loan 3 years (or more) early
- Keep the new loan amount at or under the car’s current value
Running the numbers while comparing potential new loan terms to your existing loan will determine if the savings justify refinancing.
You should also consider your financial situation – refinancing works best if your credit score is in good shape and you plan on keeping the vehicle for a while.
Here are some good times to refinance an auto loan:
- Your credit score has improved significantly
- You are currently paying a very high interest rate
- You can shorten the loan term dramatically
- Your financial situation has changed and you need lower payments
- You can tap substantial equity through a cash-out refinance
Alternatives to Refinancing a Car Loan
If refinancing doesn’t look advantageous, here are a few alternatives to consider:
Pay Extra Each Month – Making an extra principal payment every month accelerates your payoff timeline without refinancing. Even small extra amounts make a difference over time.
Defer Payments – Ask your lender if they offer deferred payment options to temporarily lower monthly dues during financial hardship.
Sell the Car – Selling the car and buying a cheaper used car is an option if the loan is very underwater or unaffordable. You take a credit hit but remove the burden.
Debt Consolidation Loan – Lumping the car loan with high-rate credit card debt via a consolidation loan can potentially lower the average interest rate you pay.
Credit Counseling – Non-profit credit counseling services can help negotiate better repayment terms on your behalf if you’re having trouble managing payments.
5 Key Tips for Refinancing a Car Successfully
Follow these essential tips when refinancing an auto loan:
1. Shop Around Extensively – Compare loan offers from at least 5 lenders to find the lowest rate for your situation. Look beyond big banks.
2. Check Credit Reports – Verify all three credit reports for errors before applying. Correct mistakes to boost your score.
3. Read All Terms Carefully – Look beyond the monthly payment and note the loan amount, rate, fees and early payoff penalties.
4. Do the Math – Use an auto loan refinance calculator to compare total costs of current vs new loan. Make sure it saves you money overall.
5. Act Fast After Approval – Lock in the rate offered by quickly submitting paperwork. Rates can change daily.
How Much Can You Save by Refinancing?
The amount you save by refinancing depends on the difference between your current and new loan terms. As an example:
- You refinance your $15,000 auto loan
- Current loan – 5 years left at 8% interest
- New loan – 4 years at 6% interest
- You save $56 per month with the new payment
- Total interest savings = $1,200 over the loan term
Even if the monthly savings or payoff reduction looks small, the total dollars saved can be significant, especially on larger loans.
Use an auto loan refinancing calculator to
You won’t be penalized for repaying your existing loan
Refinancing your auto loan means paying off your existing loan early. This could be a problem if your existing loan contract includes a prepayment penalty clause.
Take a look at your contract to see if you’ll be charged fees for early repayment. Before applying for auto refinancing, make sure to crunch the numbers so you can determine whether prepayment fees would cancel out the financial benefit of refinancing.
The fees outweigh the benefits
It’s important to look out for any fees associated with refinancing. For example, there may be prepayment penalties for paying off your current auto loan earlier than planned with your refinance loan. You may have to pay some additional interest in addition to the principal.
Even worse, some loans, such as loans with precomputed interest, make you pay all of the interest in addition to the principal.
You’re also likely to incur refinance fees. These can include lien holder and state re-registration fees. While they’re not enormously expensive, it might be a good idea to see if you can afford these fees before you refinance.
How to Refinance a Car Loan (The Right Way)
FAQ
Is it a good idea to refinance a car loan?
Refinancing and extending your loan term can lower your payments and keep more money in your pocket each month — but you may pay more in interest in the long run. On the other hand, refinancing to a lower interest rate at the same or shorter term as you have now will help you pay less overall.
How does refinancing work for a car?
Refinancing a car loan can help you save money by lowering your interest rate. The process involves replacing your current car loan with a new one, typically with a different lender. Your car will act as collateral on your new loan, just as it did on the original loan.
Does refinancing a car start your loan over?
The new loan replaces your current loan, so you do start over with a new auto refinance loan. Although refinancing starts your loan over, you can choose a new loan term that is shorter, longer or similar to what was remaining on your original loan.
Does refinancing your car payment hurt your credit?
Refinancing a car may affect your credit, but the effects are often temporary. The process involves a hard credit inquiry, which can cause a slight dip in your credit score.
What happens when you refinance a car loan?
When you refinance your car loan, you’re swapping your existing auto loan for a new one. You use the new auto loan to pay off the balance of the original loan. Then you start servicing the new loan. Why refinance? The idea is to save money. Therefore, the terms of the new loan should be preferable to those of the previous.
How to refinance a car loan?
Apply to refinance your car loan Refinancing a car loan involves getting a new loan to pay off and replace your current one. You begin making payments on the new loan, which usually has a lower interest rate or different repayment period.
What is an auto loan refinance?
An auto loan refinance is when you pay off your existing car loan and replace it with a new one. This decision could save you money or lower your payments.
How does refinancing a car work?
Refinancing a car means taking out a new auto loan to pay off an existing car loan. The new loan will likely come with a different interest rate and term. You will then pay the new lender in fixed monthly installments, just as you did with the old lender.
Why should you refinance a car?
The reasons for refinancing a car vary. If your credit has improved since you took out the original loan, or a dealership stuck you with a too-high interest rate, refinancing may lower your rate and reduce the total amount of interest you pay. If you’re struggling to make monthly car payments, refinancing can also decrease your payments.
How long does it take to refinance a car?
You begin making payments on the new loan, which usually has a lower interest rate or different repayment period. Completing an application for refinancing a car often takes less than an hour, and many lenders return a loan decision immediately. The reasons for refinancing a car vary.