How to Refinance a Car Loan

The thrill of driving off the lot can quickly fade when the car loan that fit your budget a year ago starts to feel like a straitjacket. Life’s responsibilities have come knocking, and every dollar counts.

So, what’s your next move? The good news is that you have options beyond the deal you made.

Refinancing your car loan lets you hit the reset button, trading your current terms for a new plan that helps steer your finances in a better direction. Best of all, you get to keep the car you love.

Here's a rundown of what to expect when refinancing.

What Is Refinancing?

When trimming expenses through budgeting or negotiation doesn’t render the results you thought it would, refinancing is your answer. 

When you refinance, you’re replacing your existing auto loan with a new one that has a lower interest rate, different loan term (that’s shorter or longer), or both.

The goal is to give your wallet a break. We’ll see how it all plays out next. 

Is Refinancing Worth It?

Before you go full steam ahead with refinancing, there are a few things to consider. Let’s start with the mechanics.

Refinancing Example

Let’s say you take out a car loan for $20,000 over 60 months with an interest rate of 8%. That would give you estimated monthly payments of about $406.

If you were to pay off your loan on time without missing any payments, you would pay a total of about $24,332. After 12 months, assuming you make all your payments on time, your loan balance would be down to approximately $16,611.

Now, if you were to refinance at that time and get a loan of $16,611 for the remaining 48 months with a lower interest rate of 5%, you would end up paying a total of about $18,362 on that loan. When you add that to the amount you already paid on the original loan, your total cost would be about $21,751. That’s $2,581 less than what you would have paid on your initial loan. That’s surely a win!

Curious about the math? Whether you’re buying new or used, use our auto loan calculator to gauge your monthly payments and savings. The calculator gives you all of the values in our example above except for the original loan balance after one year. To get that, you can use an amortization table like the one on Calculator.net’s Amortization Calculator. Look for the Ending Balance after one year using the inputs for the original loan.

Key Considerations

Decisions, decisions. So, what’s your top priority — monthly payments you can afford or a fast track to getting debt-free?

Extending your loan term lowers your monthly payment. Here’s the catch, though — you’ll end up paying more interest over time. Shortening your loan term, on the other hand, might increase your monthly payment, but it means you’ll pay less interest and ditch that debt quicker.

What is a Good Interest Rate for a Car Loan?

“Good” means one thing — money saved.

The rate you qualify for is tied to your credit score. Lenders look for signs of responsible credit use over an extended period. This includes on-time payments, a credit utilization at or below 30%, and a strong credit mix.

The goal is to land in the “good” category. Many lenders consider a score of 670 a great starting point. Getting your score to this level or higher can be your golden ticket to unlocking the most competitive rates.

Credit aside, lenders may also consider the following to help come up with your unique rate:

• Purchase price of the car
• Condition of the car (new vs. old)
• Your down payment

Want to know more? Find out what your credit says about you. 

When Should You Refinance Your Car Loan?

And now, here’s a checklist to help you figure out if refinancing is really right for you. Remember, timing is everything.

• Your credit score has increased
  Months have passed since you signed the dotted line, and you’ve made timely payments on each line of credit to your name. The result? Your credit score is now a few points higher than it was when you first financed your car. You should absolutely take advantage of this. A higher credit score means lenders see you as a lower risk, making them more likely to offer you a better interest rate on your new loan.
  Keep an eye on your credit report to know where you stand and what might be available to you.
• Your current interest rate is too high
  Take a look at your loan paperwork. Are you paying sky-high interest compared to the rates you see on TV and in flyers? If the answer is yes, it may be time to revisit your loan terms. With a low interest rate, you can save hundreds (even thousands) over the life of your loan.
• Your financial situation has changed
  Your life isn’t static — and your car loan shouldn’t be either. Whether you’ve gotten a promotion or started a new family, your financial needs are different now. When you refinance, you can score a lower monthly payment, interest rate, or longer term that fits your current situation and supports your future goals.

Pros and Cons of Refinancing

Other Questions to Ask Before Refinancing

Here are some additional questions to think through:

1. Are you close to paying off your original car loan? The interest you’d save in the final months of your loan may not be worth the effort and fees associated with getting a new one.
2. Are you "underwater" on your current loan? This means you owe more than your vehicle is worth. Since lenders use your car as collateral, they’re less likely to approve a new loan if its value is lower than your debt. You can check your car’s value on sites like Kelley Blue Book or Edmunds.
3. Will you incur fees? Check the fine print. Does your current loan have a prepayment penalty? You’ll want to avoid that. It’s also important to research refinancing fees from your new lender. This might include charges for transferring your car title, which can eat into your savings.
4. Does your car qualify? Some lenders have specific requirements for refinancing. For example, they may not refinance a car that is over a certain age or has a high mileage. Confirm that your car meets the new lender’s criteria before applying.

Does Refinancing a Car Hurt Your Credit?

A refi loan sounds like just the thing for you, but you’re wondering what will happen to your credit score once you hit submit. That’s understandable.

Ultimately, reducing debt that you can’t afford is a wise move. And in the long run, refinancing can improve your credit score. But applying for a new loan will result in a hard credit check, and this type of credit check means a score drop of up to five points.

The good news is that you shouldn’t have to worry about your score taking a hit each time you apply. Often, applications you submit within a 14- to 45-day window are bundled together and may be counted as a single inquiry (however this can vary so check with the credit bureaus to be completely sure). This allows you to freely compare offers from multiple lenders without fear of damaging your credit.

How to Refinance a Car Loan in 5 Steps

Ready to refinance? Here’s your game plan, broken down into simple steps.

Step 1: Gather the Important Information

Before you apply, get all your documents in order. This will make the process much smoother and faster. You will need:

• Your current loan details: Lender name, loan balance, interest rate, and monthly payment
• Your personal info: Social Security number, driver’s license, and proof of employment and income
• Your vehicle information: Make, model, year, mileage, and vehicle identification number (VIN)

Step 2: Shop Around for Lenders

Kick off your research online. You will want to find a lender with low rates, few fees, and an easy application process. Credit unions often have some of the most competitive rates and fewer fees than traditional banks.

Look for or ask about pre-qualification. This is a quick way to see potential rates and terms with zero impact to your credit score. Just remember that it’s no guarantee from the lender. You could also get pre-approved (more on that later).

Step 3: Submit Your Application

With the prep work and research out of the way, you’re ready to submit the application. If you get notice of approval from your lender (congrats, you did it!), make it a point to review the loan details to ensure the terms haven’t changed since pre-qualification or pre-approval. Then, you’ll be ready to sign.

Pro tip: If you have a low credit score, adding a co-signer with good credit can help you secure a better rate. A co-signer agrees to be legally responsible for the loan if you can’t make the payments. This extra layer of security makes the loan far less risky for the lender.

Step 4: Transition to Your New Loan

Your new lender will most likely handle the transition, settling your old loan. You can always double check with them to make sure you’re good to go.

Step 5: Start Payments on Your New Loan

Now that the transition is complete, it’s time to make your first payment on your new loan and keep going!

FAQ

The market’s always changing, making it easy to get lost in the shuffle of rising interest rates and more. Let’s go over some basics to help you master the ins and outs of auto financing.

The Takeaway

You bought your car for the freedom it gives you — hitting the open road when you please. Your loan should feel the same way. When a car payment starts to weigh you down, make a pit stop and consider refinancing. By understanding the basics and knowing when to act, you can confidently secure a brand-new deal that lets you save more of your hard-earned money.