How to Refinance Your Car Loan

Should I Refinance My Car Loan?

Refinancing a home mortgage is common, but is auto loan refinancing worth it? If you do it right, you can save more than enough money by refinancing your car loan to make it worth your time and effort. Not only can you potentially lower your monthly payments, but you may also be able to reduce the interest rate and change the length of the loan. Auto loan refinancing is also an opportunity to take your current car loan to a financial institution that you already have a relationship with.

Here's an overview of what we'll cover in this car loan refinancing guide:

  1. Why Refinance a Car Loan?
  2. How Do You Refinance a Car Loan?
  3. Where Do You Refinance a Car Loan?
  4. Why Would You Not Want to Refinance Your Car Loan?
  5. What Next?

Why Refinance My Auto Loan?

There are several great reasons to refinance a car loan, with saving money at the top of the list. According to the credit reporting bureau TransUnion, consumers lower their interest rate by an average of 2.4 percent, and their monthly loan payments by more than $50.

“Nearly two-thirds of auto finance companies offer refinancing, but according to a recent Harris poll, less than half of consumers are aware they may use this option as part of their overall financing strategy,” says Brian Landau, senior vice president and automotive business leader at TransUnion.

Piggy bank savings

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Even with interest rates slowly climbing, there are still plenty of ways to save with auto loan refinancing. TransUnion’s report showed that many consumers refinanced their original vehicle loan within days of signing the papers.

Get a Better Deal

Sometimes, you just don't get a great deal when you initially finance your vehicle. Maybe you weren’t prepared, bought on the spur of the moment, or didn’t succeed in getting a great rate during your negotiations. Whatever the case, if your original car loan interest rate is well above what you are seeing advertised, you should shop for an auto refinance deal. Trading a high-interest rate for a low-interest rate is the quickest way to save money on a car refinance.

When you get your original financing at the car dealership, it’s easy to get confused by all of the numbers and simply buy based solely on the monthly payment. You should go back to your copies of the documents you signed to check the interest rate on your loan. If it is higher than the market rate, look for another lender with better terms.

To Take Advantage of an Incentive

Sometimes you have to use a manufacturer’s financing to get a cash back offer (sometimes called a rebate). If the interest rate for that loan is higher than what you can find elsewhere, it’s a good reason to refinance the loan.

You need to do your research, though, as many cash back offers require you to keep the manufacturer’s required financing for a certain time period. Those periods vary from deal to deal, so check your paperwork to see how many months have to pass before you can seek a new finance deal. Some loan deals allow you to turn around almost immediately and get a new auto loan.  

To Move It to Your Primary Financial Institution

Having your auto loan at the bank or credit union where you do the most business is beneficial for several reasons. Not only are you likely to receive additional benefits or discounts for having all of your business under one roof, but it also makes it easier to work with the loan.

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Since most people now have their paychecks deposited straight from their employers to their checking accounts, it's super convenient to set up automatic payments from your checking account straight to your auto loan. If there are ever issues with a payment not being applied to your loan, it's easier to work with just one institution to get it straightened out.

To Change the Length of Your Loan

If you want to lengthen or shorten the term of your loan, an auto refinance is a great way to do it. Say your original financing was for four years, but your loan payments are stretching your budget. With a refinance, you may be able to stretch the payments out to five years (or more) to come up with an amount that's easier to make. By increasing the length of your loan, however, you might end up paying more interest in the long run.  

You can also use a refinance to shorten your car loan. Why not just make oversize payments to reduce the time it takes to pay off your current loan? Because a shorter-term vehicle loan will likely come with a rate discount, and that will save you even more money.

Your Credit Score Has Improved

If you had bad credit when you took out the car loan, but have been making on-time monthly payments for a while, your credit score has likely improved. You will have also made a dent in the balance of your current auto loan, lowering its loan-to-value (LTV) ratio as long as your payments outpaced depreciation. The lower the LTV ratio, the more attractive your loan is to a new lender.  

“You’ve shown that you can be responsible,” says Joe Pendergast, Navy Federal Credit Union’s vice president of consumer lending. “If you can go in and refinance and get a lower rate, it would be a very smart financial decision to do so.”  

If you had bad credit when you took out the old loan, you probably didn’t qualify for low rates. With better credit, however, you might qualify for low rates when you apply for a new loan. The new rate may allow you to significantly lower your monthly payment, shorten the length of your loan, or both.

Your Lease is Ending

It’s not technically an auto refinance, if you decide to purchase the vehicle you’re driving at end of the lease, you’ll need to find a used car loan to pay for it. You may qualify for new car-loan rates at some lenders. After all, a vehicles coming out of a lease is usually just a few model years old, and you’ll probably have better credit from making on-time payments. Some lenders may consider your lease return a used car, and propose a somewhat higher used-car loan interest rate.

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You should approach financing an off-lease car just as you would any other car loan, and get offers from several lenders before you head to the dealership to return your lease. Trying to get new financing the same day as you’re returning the car won’t give you much of a chance to find a better auto loan than what the dealership offers.  

How Do You Refinance a Car Loan?

Applying for auto loan financing is similar to the process you went through for your current car loan. You start with a loan application, receive an approval or denial, and get the funds to pay off your old car loan.

Apply for the New Loan

Whether you’re applying with an online lender or one with brick-and-mortar locations, the first step in the loan process is filling out a loan application. It will ask you about your debts, any credit cards you have, your employment history, how much you pay for housing, and a host of other questions that the lender will use to assess how likely you will be to pay back the loan. While you might be asked for personal and demographic information on the application, the lender can only use information allowed by law to decide whether to lend you money.

The lender will take the information from the loan application and combine it with what they learn from your credit report. They’ll make a decision on whether or not to loan you the amount of money that you are seeking, and determine the terms that will apply to the vehicle loan. If you are a high-risk borrower, for example, they may approve your loan, but with a higher interest rate or a shorter loan term than you asked for.

If a lender denies your application for credit, they are required to tell you why. The credit bureau that they used to determine your creditworthiness is also required to provide you with a copy of your credit report, free of charge. Lenders decline loan applications after they have determined there’s a high likelihood that it will not be repaid. While being declined for a loan can be frustrating, in the long run, it may keep you from digging a financial hole that you can't escape.

The Importance of Your Credit Score

Perhaps the most critical thing that lenders look at is your credit score. It’s a three-digit number ranging from 300 to 850 that summarizes the information found in your credit reports. You actually have several credit scores, as each of the three leading credit reporting companies – Equifax, Experian, and TransUnion – have slightly different models that they provide to different lenders. Sometimes you’ll hear credit scores referred to as FICO scores, though the Fair Isaac Corp. (FICO) model is just one method of determining a score.

Excellent credit score

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Lenders use the score not only to determine whether you will be approved for an auto loan, but also to decide what interest rate you will have to pay and the length of the financing that they will offer.

Because lenders lean so heavily on your credit score, it’s critical that you know it and work to correct any errors in your credit history well before you embark on an auto refinance. It’s especially important to do so if you are working with a new lender who doesn’t know you. It can take several on-time monthly car payments to move your credit rating up just a few points, so you’ll want to plan ahead for future borrowing.

How Do You Compare Auto Loans?

While you might be tempted by loans with low monthly payments or low rates, that’s not a good way to select financing. Instead, you need to look at the total cost of the loan, including all of the interest that you have to pay. It’s a good idea to break out a calculator and do the math yourself, as it helps you to understand the terms of the loan. That way, the lender can’t manipulate the numbers to make their option look more attractive than it is.

Thankfully, the math to figure out the total cost of auto financing is pretty simple. First, plug the amount of the loan, the interest rate, and the length of the loan into our car loan calculator to determine the monthly payment. Then multiply the payment by the number of months in the loan term to determine the loan cost.

Here’s an illustration to show you how it works. Let’s say that you’re refinancing $18,000 of your car loan at 5 percent for four years. Using our auto loan calculator, we see that the monthly payment on the new loan is $415 per month. Multiply the $415 by the 48 months in the loan term, and you'll see that the total loan cost is $19,920.

Note that the math also shows you the total interest that you’ll pay during the life of the loan. You subtract the loan amount from the total cost of the payments, and you'll find the total interest. In this case it's $19,920 minus $18,000, or $1,920.

Now, let’s say that you received another loan offer for five years, but with a 6 percent interest rate. Our car loan calculator shows a payment of $348 per month, which sounds great compared to the four-year deal. However, when you multiply the $348 by 60 months, you can see that the total cost of the loan is $20,880. By extending the loan out a year, you’re adding almost $1,000 to the cost of your financing.

In general, you want to have the shortest auto loan that you can afford the monthly payments on. Not only do shorter loans typically have lower interest rates and lower overall prices, but you'll also have much less risk of owing more for your vehicle than it is worth (also called being underwater or upside-down). There’s also a better chance that your car will be paid off before your warranty expires, after which the possibility of expensive repair bills increases.

Sign the Paperwork

Some lenders allow you to sign the new auto-loan paperwork electronically, while others require you to come into the office and sign the papers. Regardless of where you do it, you need to read everything before you sign to ensure that the new loan paperwork is correct and complete. Pay close attention to the amount you are borrowing, the length of the loan, and the interest rate. If any spaces are left empty, or information is incorrect, make sure the dealer takes care of it before you sign the paperwork. Once you sign your name, proving that you did not intend to agree to the terms becomes much more difficult.

Where Do You Refinance?

You can refinance an auto loan at many of the same places where you finance a vehicle in the first place. However, you’ll want to avoid places that act as agents for other lenders, such as car dealerships. To pad their profit, many of these middlemen mark up the financing offers before presenting them to you.

Most large national banks, both online and brick-and-mortar, offer a wide array of loan services and have automated operations that can make the process of auto loan refinancing easy. They may not always offer the lowest rates you can find, but most will occasionally feature attractive low-interest loan specials.

Community and regional banks offer many of the same services as their larger competitors but often can provide more of a personal touch. This is good for borrowers who need extra help through the process, or for those who need to explain their financial circumstances to someone. Like other banks, they offer competitive rates, especially when they are running promotions with interest rate discounts.

Credit unions currently dominate the auto refinance space, according to TransUnion, accounting for the majority auto loans that are refinanced. Credit unions are member-owned cooperatives that typically provide lower interest rates to their members than other types of financial institutions are able to offer. Not everyone can join every credit union, but the National Credit Union Administration has a credit union finder on its website.

Customer interacting with bank teller

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When you start shopping for an auto refinance deal, starting with the bank or credit union where you do most of your business is a great idea. Many financial institutions offer relationship discounts to customers who also have savings accounts, mortgages, checking accounts, or credit cards. You will also want to get an offer from the place where you have your current auto loan, whether it’s an automakers captive finance company or another financial institution. They likely won't want to see you go to another lender, which may motivate them to make you a great car refinance deal if you elect to stay.

Why Would You Not Want to Refinance?

While many consumers can benefit greatly from a car loan refinance deal, not all car buyers will come out ahead if they refinance their car.

When There Is a Prepayment Penalty

Before you decide to refinance your auto loan, you'll want to scrutinize your loan documents and disclosures. Some car loans come with prepayment penalties designed to dissuade you from refinancing your loan and taking it to some other lender. Depending on the language in the contract, you may have to wait months or even years before you can jump ship.

Unless the waiting period is very short, you usually don't want to get a loan with prepayment penalties. If your car is totaled or stolen before the penalty expires, you'll have to pay extra money to get out from under the loan.

If You Have Declining Credit

Let’s say you had good credit when you took out the original car loan, but you've missed payments here and there, and your credit rating has dipped into the fair or poor range. In this case, you probably have more to lose than gain from an auto loan refinance. The only exception is if you desperately need to extend the length of the loan so that you can get lower monthly payments.

Trying to get a new loan when you know you have bad credit can be a dangerous game. When you apply for an auto refinance, the lender will pull a credit report from one or more of the three major credit reporting bureaus – Equifax, TransUnion, and Experian. That inquiry will lower your credit score a few more points, making it harder to pull yourself out of the bad credit spiral.

When You Have a Zero Percent Financing Deal

If you were able to take advantage of a new-car deal with zero percent financing, there’s no reason to think about a car refinance. You’re already getting free rent on the money that you’re borrowing, and free is a very good price.

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Even if your interest rate isn’t quite zero, but it’s still well below market rates, refinancing does not make good financial sense. In fact, it doesn’t make sense to do anything to accelerate your repayment of the loan, unless you’re ready to buy a new car or you enjoy the feeling of not having a car loan.

When Your Car is Almost Paid Off

If you're nearing the end of your car loan, it probably does not make sense to refinance. Unless you have a sky-high interest rate, payments made in the last year or so of a loan go primarily toward the principal, and not the interest. Any savings that you might achieve from refinancing to a lower rate would likely be relatively small, and not worth your time to pursue. A lender would probably charge fees that you would never recoup through any savings. In fact, you would be hard-pressed to find a lender who would put effort into a loan with very little profit left in it.  

When You’re Upside-Down on Your Current Loan

If you owe more money on your current car than it is worth, it’s probably not a good time to try to refinance. Lenders tend to charge higher interest rates when your loan-to-value ratio exceeds 100 percent. In fact, you would likely have trouble finding an affordable, responsible lender to issue the loan.

The exception to this rule is if you have an exorbitant interest rate, but your credit score allows you to get a much lower rate.

When You’re About to Apply for a Mortgage

Credit bureaus look at the number of credit inquiries as an indicator that you may be having financial difficulties. If they see inquiries for an auto loan at the same time as you’re applying for a mortgage, it may affect your ability to get the home loan or your home loan interest rate.

It's best to separate the two financial events by a few months so that they don't interfere with one another in your credit history.

What Next?

The most critical next step is to make sure that the proceeds of the new loan are used to pay off the entire balance of the old loan. Even if the new lender assures you that everything is taken care of, it is your responsibility to ensure that the repayment happens.

Unlike with new car loans, auto loan refinancing requires that the vehicle's title be transferred from the original lender to the one that handles your refinancing. Just like with your initial loan, your vehicle is the collateral, and the lender will hang onto the title for that collateral until the loan is paid off. While some lenders may send the title directly to the new loan company, others will send it to you, and you'll have to get it to the new lender quickly.

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You will also need to verify that you have the car insurance required by the company that holds your new auto loan. Different lenders require different limits and deductibles, though they generally require enough comprehensive and collision coverage to ensure that as much of the loan as possible is repaid if the car is stolen or totaled. The insurance required by lenders is in addition to the liability coverage that is legally required in most states.

It's a great idea to set up automatic payments to ensure that you make your monthly loan payments on time, and so you don't forget to make a payment. If you have a car loan and a checking account with the same financial institution, it's easy to set up automatic payments, especially if you have direct deposit with your employer. If it is from a different financial institution, you can use your bank or credit union's electronic bill payment system to create automatic payments.

What if You Can’t Make Your Car Payments

Sometimes things happen in life that make it impossible to make your monthly payments. If it looks like you are going to have a problem making your car payment, it is critical to communicate with your lender before you miss a payment. Many lenders can defer payments for a short time if you're having a short-term issue, or they can work with you to find a solution that is suitable for both of you. When you defer payments, your interest will still accrue so you might have to make an extra car payment or two at the end of the loan term. Generally, the lender doesn't want you to default on your loan any more than you want to, and they will do what they can to help you out.  

Couple discussing documents

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Unfortunately, sometimes you have no choice but to default on your auto loan. In this case, your lender will likely want to repossess the vehicle so that they can sell it to recoup some of their loss. Some consumers don't want to give up their wheels and will make the repossession more difficult. What they don't realize is that, in most states, the lender can attempt to recover the cost of repossessing a vehicle and add it to the loan balance or any judgment that they are able to get. It's a better idea to do a voluntary repossession and drop your car off to the lender or their agent.

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