How do You Refinance a Car? (Plus When to Avoid Refinancing)

person using calculator to calculate refinance loan options
How do you refinance a car? - Car and DriverCatherine McQueen - Getty Images

If your car payments are too high or you're paying too much interest, you might wonder, "How do you refinance a car?" Refinancing a car can earn you a better interest rate, which might mean lower monthly payments.

You might also refinance a car loan to pay down your debt faster. In this guide, we’ll explain how you can refinance your car, including when you should and shouldn't refinance a car loan.

Looking to refinance? Easily compare rates from auto lenders below.

What Does Refinancing a Car Mean?

Refinancing a car means you're replacing your current auto loan with a new one. The new auto loan pays off your current car loan. While you have to reapply for new loans and sign new loan paperwork, refinancing has many benefits, including:

  • Save money: If you refinance your car at a lower interest rate, you can also lower your monthly payment. Lower interest rates are one of the primary reasons to refinance.

  • Pay less interest: If you’re able to refinance with a lower interest rate loan, you’ll pay less interest over the lifetime of the loan. Less interest means you pay less in total for the car purchase.

  • Lower your debt-to-income ratio: Reducing your monthly loan payments also lowers your debt-to-income ratio. This helps you maintain a good credit score, which can be helpful if you apply for other loans in the future.

  • Opportunity to pay off your car faster: If you can lower your car payment, you might be able to put more money more toward the loan balance. This can help you pay off your current loan faster, which reduces the chance of an imbalance between loan to value, or negative equity.

When Should You Refinance a Car?

Not sure if refinancing is the right choice for you? Here are some situations where it might make sense to refinance your current loan.

  • Interest rates have dropped: If average auto loan rates have gone down, it might be the right time to refinance your car loan. Reach out to a few lenders to determine their current interest rates for refinancing.

  • Your credit score has increased: Making on-time payments on your original car loan can help improve your credit score. If your credit score has improved, you might be able to refinance and get a better interest rate, which will potentially reduce your monthly payment.

  • Your car payments have gotten too expensive: Maybe your financial situation has changed, and you can no longer afford your loan payment. Getting a new loan might lead to more favorable terms. You might also be able to spread your remaining payments over a longer loan term to save money.

  • You made mistakes when signing your first loan: If you didn't do your research when applying for your current loan, you might be paying too much. Refinancing with a new lender can help you make up for previous mistakes.

  • You want to access cash equity: Some lenders offer cash-out refinancing programs. Similar to a cash-out home equity loan, the bank refinances your loan and gives you the difference between your car's value and the loan in cash. This might be an option if you need access to cash for other purposes, such as home improvements or vehicle repairs.

When Shouldn't You Refinance a Loan?

Depending on your situation, refinancing your auto loan may not be advisable. An auto refinance might not be right for you if:

  • Your old loan charges a prepayment penalty: Some lenders charge prepayment penalties, making it unwise financially to refinance a car loan. Always calculate any fees when evaluating the true cost of refinancing your car.

  • Your auto loan is not current: If you have missed car loan payments, you might not qualify for refinancing. Even if you do, missed or late payments lower your credit score, making it difficult to qualify for a better interest rate.

  • You have negative equity: If you have an upside-down car loan, you might have to pay out of pocket to refinance your loan. While some lenders allow you to roll the previous loan amount into the new loan, this will usually increase your monthly payment.

  • You already have a competitive interest rate: If you're already locked into a competitive interest rate, it might not be worth it to change loans. The difference in payments should be enough to cover any fees when deciding whether to refinance your car.

  • Your credit score dropped: If you missed payments on other loans or took out additional debt, it might not be financially smart to refinance. If your credit score dropped significantly, you might end up paying more.

  • Your auto loan is almost paid off: Because you pay most of the interest on an auto loan at the beginning of the loan, you might not want to refinance if the loan is almost paid off. You could end up paying more interest by moving the loan to a new lender.

How to Refinance a Car

Once you decide that refinancing makes sense, you can follow these steps:

Understand Your Current Loan

It's important to fully understand your current loan so you can choose the right auto finance loan for your financial situation. Here are a few things to pay attention to:

  • Current loan payments

  • Loan amount balance

  • The total cost of your loan

  • The interest rate on the original loan

You can usually find this information on your original loan documents. Even if you can't find your current loan documents, you should be able to request them from your lender. Ask them for a payoff quote, as some lenders charge prepayment penalties, even when refinancing.

Gather Important Documents

You'll also need certain documents to apply for a loan with a new lender. This includes your vehicle identification number (VIN), driver's license number, home address, Social Security number, and employer and income information. The lending financial institution treats the refinancing loan process like applying for any other car loan.

Check Your Credit Score

You'll likely need a good credit score to qualify for a better auto loan than you currently have. You can also work on improving your credit report and wait to refinance until you can qualify for better auto loans. Improve your credit score by making loan payments on time each month. Missing payments, even one or two, can have a significant negative effect on your credit score.

Pay down any debt you have, including credit cards or student loans. Most financial institutions look at your debt-to-income ratio.

Research Lenders

Research lenders to compare their loan terms. Also compare any new loans you're considering with your current auto loan. Banks, dealerships, or your local credit union might all offer auto refinancing. If you recently became a credit union member, you might qualify for a new auto refinance loan with them.

Credit unions typically offer better loan terms than other financial institutions, but also have stricter lending requirements. Compare fees among lenders, as well. You'll want to verify the loan application requirements for each lender to make sure you meet them.

For example, some lenders have rules about a car's age or mileage when determining if a borrower qualifies for a new car loan. Make sure you also check with your current financial institution. They might be willing to refinance your loan and lower their fees to keep you as a customer.

Set a Budget

Consider how much you're paying now and how much you would like to save on your monthly payment. This can also help you choose your ideal loan term when comparing lenders. Shorter loan terms have higher monthly payments, but you pay less interest over the life of the loan. Longer loan terms mean cheaper monthly payments, but you'll pay more in interest.

Calculate the Savings

Before submitting the loan paperwork to refinance your existing loan, make sure the savings add up. The primary goal of auto loan refinancing is saving money. You can find auto refinance calculators online that can help you measure your costs.

You must also factor in additional costs, such as loan origination fees. The lender might also request a down payment. Even if they don't, it's best to put something down on your new loan to keep the payments affordable and prevent negative equity.

Apply for a Preapproval

Applying for a preapproval can help you explore your refinancing options without taking a hit on your credit score. Submit a new loan application with a few lenders at one time.

This makes it easier to compare multiple lenders at once. Also, as long as you submit the applications around the same period, they will only count as one inquiry on your credit report.

Pick a Lender and Sign the Contract

Choose which bank or credit union you want to hold your new loan. Once you complete the auto financing application and the lender approves it, they'll issue payment to your previous lender.

Instead of making payments on the original loan amount, you'll now pay the new lender. Your loan payments will hopefully be cheaper, giving you more money for other areas of your monthly budget.

Does Refinancing Affect Your Credit Score?

Refinancing an auto loan does impact your credit score. Your score might drop by a few points as the inquiry hits your credit report. However, a few points aren't usually a big deal and will likely even out shortly, assuming you continue to have a good payment history.

Refinancing lowers the average age of your credit accounts, which is a key factor in calculating a credit score. But lower monthly payments might make it easier to continue making them on time.

If you apply for an auto refinance with multiple lenders within a few weeks, it shouldn't negatively affect your credit. As long as the credit inquiries are for a similar purpose, they will only count as one inquiry.

Monitor your credit scores after applying for or refinancing an auto loan. The sooner you notice any errors or discrepancies, the faster you can dispute them and better protect your credit history. Always review the car loan advertiser disclosure so you know what you're signing and how it might affect you.

Alternatives to Refinancing a Loan

If you can't qualify to refinance your existing auto loan, you might have other options, including:

  • Ask for lower monthly payments: Your lender might work with you if you're having difficulty making your monthly payments, particularly if you've been on time with prior loan payments.

  • Sell your car: If your monthly payment is too expensive, you might decide to get rid of the loan by selling the car. Auto loans typically require you to pay the loan in full when you sell it, so if you accept an offer for less than what you owe, you'll be responsible for paying the difference.

  • Roll the loan into a new one: Some car dealerships offer trade-ins where you can roll the leftover loan amount into a new loan. However, this rarely gets you a lower monthly payment.

  • Time your refinance carefully: Even if you don't qualify for a good rate now, you might be able to in the future. Work on your credit, and time your application for when you're likely to get better rates.

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