Refinancing Your Auto Loan

One way to save money on your car is by refinancing your loan — a financial tactic you can do in multiple ways.

Refinancing car loans means changing the basic terms of the bank agreement you used to buy your vehicle. Terms include the interest rate, any additional down payment, the length of the loan and the loan balance.

You can adjust the financing through your current lender, which may save you money on fees, or you can find a new lender. Either way, the goal is to replace your current car loan with a new loan that has better interest rates,  a lower monthly payment and, hopefully a faster payoff.

Although financial experts prefer that we all buy our cars with cash, thus avoiding long-term interest payments on a depreciating investment, that’s not realistic in a culture where even new compact cars cost more than $20,000 and used cars are holding higher values.

In America, auto loans are the most common way people afford a car. Let’s look at the different ways you can refinance your car loan.

Decide if Refinancing Is Right for You

The reason many people look into refinancing their car loan is that they can’t afford car payments on their existing loan. Refinancing lets you adjust the terms of your current loan to make monthly payments more affordable.

Among the reasons why people refinance auto loans include:

• Lowering the APR. Your annual percentage rate (APR) is a major part of lowering your monthly payment. You want to get this number as low as possible. Lenders use several factors to calculate your APR, including your credit score and debt-to-income ratio. If your financial situation has improved since you originally took out your loan, you may qualify to refinance at a lower APR. Similarly, if auto loan interest rates have fallen since you took out the loan, you may refinance at a lower rate. Finally, if the remaining loan amount is less than the value of the car (positive equity), you could also secure a lower APR.
• Saving money. Even if your financial situation hasn’t changed — or if the market interest rates remain the same (or close to the same) — refinancing could still save you money. This is wise if you didn’t shop for better rates originally. Securing a new rate that is two or three points lower than your current rate can generate significant savings over the life of the loan.
• Paying off the loan faster. If your financial situation has improved significantly since you took out the loan, refinancing over a shorter term could help you get out of debt quicker and improve your debt-to-income ratio. Although your monthly payments will rise, you will end up paying less interest over the life of the loan.

Conversely, refinancing for a longer term could lower your monthly car payments and provide wiggle room in your budget. However, even though a longer repayment period lowers your monthly payment, it translates into higher interest costs over the life of the loan.

Although often beneficial, refinancing is not a one-size-fits-all solution to fixing a bad car loan. Times when refinancing is not the smartest option:

• If you are behind on your payments. Being behind on monthly payments for the existing loan or other credit issues will lower your credit score and could prevent you from qualifying for better terms.
• If your current loan has a prepayment penalty. A prepayment penalty is a fee charged for paying off your loan early. The prepayment fee is typically 2% of the remaining loan balance, which might cancel out the savings from refinancing.
• If you owe more than the car is worth (negative equity). Having negative equity on your vehicle can make securing better terms challenging.
• If you have an old vehicle. Many lenders have restrictions on vehicle age and condition. A good number of lenders will not allow you to refinance on a car that is more than eight years old or has at least 100,000 miles. This lowers the resale value of the car significantly, thus making your loan riskier to the lender.

Before you refinance your car loan, assess your objectives, the resulting implications of a refinance and the terms of your current loan.

Review the Terms of Your Current Loan

Look at your existing loan first. Review all the terms of the loan so you can accurately compare it to potential new loans. Look at:

• Your current monthly payment
• Your current APR
• The number of months left on your current loan
• The amount to pay off your existing loan

Note that your payoff is not always the same as the remaining loan balance. Also, most lenders require a minimum remaining balance of between $3,000 and $7,500 to refinance.

Many lenders will refinance for terms of at least 12 months. While you can still refinance when you have less than a year left on your loan, it may be more affordable just to pay off your existing loan.

Determine the Current Value of your Car

If paying off the loan is still viable, determine what your vehicle is worth. Lenders usually won’t lend more money than what the car is worth. Calculate your car’s loan-to-value (LTV) ratio. A lender will want it to be below 125% to qualify.

To determine the LTV ratio, divide the current loan balance by your car’s current value. Find the current value of your car online through Edmunds and Kelley Blue Book.

Most lenders won’t refinance a loan that has negative equity until you get into a positive equity standing or unless you have excellent credit. You can achieve this by continuing to make on-time monthly payments with an extra amount added. However, make sure that the lender applies the extra amount to the loan principal and not to the interest.

Compare Refinance Rates

Once you understand the details about your existing loan and the current value of your car, you can shop for better terms. Ask yourself: How much can you afford to pay?

Because every lender has specific underwriting criteria, we advise you to request quotes from multiple sources: banks, online lenders and credit unions. You can also use these quotes from other lenders to negotiate better terms with your current lender.

Most lenders will pre-qualify you online with a soft credit inquiry, which allows you to weigh different offers without hurting your credit score. However, getting pre-qualified is not a guarantee for approval. It only provides you with estimated loan terms.

A car loan refinance calculator can help you compare your existing loan to a pre-qualified loan offer. You can also reach out to the lenders directly and ask them about their rates and terms.

Here are questions to ask potential lenders:

• What APR can you offer me based on my credit profile?
• What fees do they attach to a refinancing (application, origination, etc.)?
• Is there a prepayment penalty if I decide to pay off the loan early?
• How long are the loan terms you offer for refinancing?
• Do you have any vehicle restrictions based on age or mileage?
• Do you offer an autopay discount?

By doing diligent research, you can make your loan application with confidence that you chose the best option.

What rates can you expect when you refinance an auto loan? Here is a list of popular lenders and their estimated rates.

We recommend your first stop to be a local bank or credit union. You must be a member of a credit union to do business with one, but it doesn’t cost money to join a community credit union. Your loan is your membership card.

Apply for Financing

Once you find the right deal and are confident about being approved, it’s time to start the formal application process. You must provide the lender with the following documents and information:

• Personal information, including your driver’s license, social security number, and other identifying details.
• Proof of income, such as recent pay stubs, tax returns, employment history, W-2s or bank statements.
• Proof of residence, such as a utility bill, lease agreement or mortgage statement.
• Proof of auto insurance by providing your insurance card or other proof of current insurance.
• Current loan information, including the payoff amount, interest rate, remaining term and who your current lender is.
• Vehicle information, including the year, make, model, mileage and vehicle identification number (VIN).

The application process will differ from one lender to another. For some, you can apply online or over the phone. Others require an in-person visit.

When you get your loan approved, you will get final loan disclosures and paperwork to sign. Read and understand the terms of the new loan. Confirm that this deal will fulfill the financial objectives you started with.

Once you sign, your new lender will then send you a document with all the terms of your new loan. It will tell you when your payment is due, what your minimum monthly payment is and what your payment options are.

Your new lender will either pay off your old loan or provide you with the funds to do so yourself. If the lender is paying off the loan, follow up to make sure they do.

The only thing left to do is to make on-time monthly payments on your new loan.

Frequently Asked Questions

Still not sure about refinancing your auto loan? Here are some commonly asked questions on how to refinance a car loan.

How Much Can I Save?

How much you save by refinancing depends on several things, including the difference between your new interest rate and your current rate, your remaining loan balance and the term length of the new loan. An interest rate change carries the biggest impact. A reduction of only 1% can net you significant savings over the life of the loan.

Does Refinancing Hurt Your Credit?

Because credit inquiries hurt your credit score, at least at first, the refinancing process will hurt your credit some. Although prequalification usually has no impact on your credit, refinancing a car loan involves several credit checks. Upon receiving your formal application for refinancing, your lender will perform a hard credit inquiry, which will lower your credit score by five points. However, your score should rebound within a few months, provided you make on-time payments.

Do I Need to Pre-Qualify?

You don’t need to pre-qualify when you refinance your car loan. However, we recommend it because it allows you to receive and evaluate multiple loan offers without hurting your credit score.

How Does Refinancing Impact My Car Loan?

Refinancing a car loan replaces your existing loan with a new loan from a different lender (or the same lender) with different terms, including interest rate and loan term. Refinancing doesn’t change who owns the vehicle. Your new lender becomes the lien holder on your car title until you pay off the loan. Also, refinancing may terminate other products you bought with the original loan, such as GAP insurance or an extended warranty. Contact your providers to understand how a new line affects their products.

Can You Refinance Your Car with Bad Credit?

You can refinance a car loan if you have bad credit, although you won’t qualify for the best interest rates. Lenders typically perceive borrowers who have lower credit scores as higher risk and thus charge higher APRs to account for this risk. So, explore options from online lenders and credit unions, which have more accommodating lending criteria than traditional banks. Alternatively, work on improving your credit score before trying to refinance. The better your credit score, the better rate options you’ll have.

Can You Refinance Your Loan with the Same Lender?

You can also refinance your existing loan with the same lender. We recommend that if you’ve decided to refinance that you shop at other banks, credit unions and online lenders who may have competitive rates and terms. You can also use offers from other lenders to negotiate better terms with your current lender.