A car is one of the largest purchases you will ever make. For most people, this purchase is second only to their home. The loan you get for your vehicle will impact your monthly budget. People who feel like they didn’t get the best deal and want better terms may consider an auto loan refinance.
Even if the terms aren’t perfect, auto loans serve an essential function. These financial products make it easier for people to afford cars. Instead of making one large payment, auto loans break your purchase into several monthly installments spread over a few years. However, you don’t have to stick with the same auto loan from start to finish.
Some car owners refinance their auto loans, effectively changing their loan terms and interest rates in the process. You can save money, get out of debt faster, or access extra cash with a refinance. This guide will walk you through how auto refinancing works and how to get better terms for your loan.
What Is Auto Refinancing?
Auto refinancing is the process of replacing your current auto loan with a new auto loan. The new auto loan’s principal gets used to pay off your current auto loan. Then, you continue to make monthly payments based on the new auto loan’s terms and rate.
Where to Refinance Your Vehicle
You can refinance your vehicle with a traditional bank, credit union, or online lender. Each of these entities offers different terms, rates, and delivery times. Online lenders tend to give you financing quicker than traditional banks and credit unions, but it varies for each lender. It’s also possible to find loans with lower credit score requirements if you go with an online lender. However, borrowers may end up with lower interest rates with a traditional bank or a credit union. Reaching out to several lenders can help you find the best terms and interest rates for your next auto loan.
When Should You Refinance Your Auto Loan?
You shouldn’t refinance your auto loan just for the sake of it, but doing so at the right time can help you save money. These are some of the scenarios when it makes sense to refinance your existing auto loan.
If Your Credit Score Has Improved
Lenders look at your credit score when determining your interest rate. A higher credit score entitles you to a lower interest rate, but you may not have had the best credit score when you first applied.
Consistent on-time payments for your current auto loan probably increased your credit score. Payment history makes up 35% of your credit score, and you have likely built a more extensive credit history since you got your current auto loan. Applying for a new loan with your higher score can result in a lower interest rate and potentially save you thousands of dollars in interest.
If Your Current Lender Increased Your Rates
If you have a variable-rate loan, your interest rate can go up. Your rate can go up based on changes to index rates, and your lender will follow suit. If your lender increases your interest rate, shopping around for another auto loan can help you secure a more favorable rate.
Getting a fixed-rate loan eliminates the risk of your interest rate rising during the loan’s term. While fixed-rate loans are less advantageous during economic cycles of declining interest rates, these loans give borrowers more stability. You know what you will have to pay each month for an auto loan, while variable-rate loans may exhibit fluctuating monthly payments.
If You Can’t Keep Up with Your Car’s Payments
Auto refinancing isn’t only for people who have improved their credit scores. Some people refinance their loans to reduce their monthly payments. Turning a 2-year auto loan into a 3-year auto loan spreads the principal across more months and lowers your payments in the process. You will be in debt longer, but trimming your monthly expenses by $100 can make a big difference.
If Interest Rates Have Gone Down
Declining interest rates give borrowers the opportunity to refinance their way into lower-rate loans. A lower interest rate will reduce your monthly expenses and make your auto loan payments more manageable. Those savings can offset the expenses you incur from administrative fees, closing costs, and early payment fees, if applicable.
Your Financial Situation Improved
If your finances have improved, you can use an auto refinance to get out of debt sooner. Some people want to turn a 2-year auto loan into a 1-year auto loan, so they stop making monthly payments sooner. Better finances can also help you secure a lower interest rate since you will have a more attractive debt-to-income ratio. Borrowers should consider how higher monthly payments will impact their ability to cover other expenses before committing to this type of auto loan refinance.
You Didn’t Get the Best Deal the First Time
If you are not happy with your current loan, you can also refinance your way out of it. Some car buyers get stuck with undesirable auto loans because their choices were limited at the time. Your first auto loan may have been necessary to build your credit score, typically resulting in higher rates. On-time payments and better finances can help you qualify for better loan offers. You don’t have to stick with a bad loan if you know you can easily get a better one.
When You Should Hold Off on Refinancing
Refinancing your auto loan can present many benefits, but it is not the right decision for everyone. These are some of the scenarios when it makes sense to hold off on refinancing your auto loan.
You’ve Paid Off Most of Your Current Loan
Refinancing your auto loan costs money, and it’s more difficult to absorb those costs for a short-term loan. If you only have a few months left on your auto loan, it makes more sense to stay the course instead of incurring administrative fees and closing costs for your loan.
Working a temporary side hustle to cover the monthly payments, if necessary, will help you through the last few months of your loan. Once you get through those last few payments, you will open more space in your budget for other expenses. You may be able to invest more money and get closer to your long-term financial goals by paying off your balance instead of prolonging the loan.
Your Car is Old or Has Tons of Miles
A car with a ton of miles is riskier for the lender. The lender can get stuck with a bad asset if the car breaks down and the borrower defaults on the loan. That increased risk will result in a higher interest rate if you even get the chance to apply for a loan. Some lenders won’t want to get involved with your vehicle if it has too many miles. Auto refinancing may not be the best idea for drivers who have racked up over 150,000 miles on their cars. If your vehicle model is more than 10 years old, you may want to consider making the current monthly payments instead of seeking an auto refinance. Some lenders have earlier cut-offs for each of those factors.
Refinancing Costs and Fees are Too High
Refinancing can get expensive and become impractical for some borrowers. High costs and fees can negate the impact of securing a lower interest rate on your new auto loan. Before committing to a loan offer, borrowers should assess the expenses of refinancing their auto loans.
You may be able to put these costs at the back of your loan and extend its duration to secure monthly payments. While this approach can create immediate space in your monthly budget, you will stay in debt longer and pay more interest over the life of the loan.
You’ve Taken Out Other Loans or Planning to in the Future
Refinancing an auto loan will trigger a hard credit inquiry, an event that reduces your credit score by a few points. Your credit score can recover within a few months, but getting a hard credit check right before applying for a loan or a line of credit is not a good idea.
If you are applying for a significant loan, such as a mortgage, you shouldn’t refinance your auto loan a few months before. Losing points on your credit score can hurt your chances of applying for another loan. Even if you still get the mortgage, credit line, or similar financial product, you may end up with a higher interest rate and a lower loan amount.
What are the Benefits of Auto Refinancing?
Auto loan refinancing offers several benefits for borrowers. These are some of the perks you can capitalize on, depending on your objectives and how you refinance the loan.
Lower Monthly Payment
Refinancing your auto loan can reduce your monthly payments. It’s a popular reason to refinance auto loans. You can secure a lower interest rate or extend your loan’s duration to make auto loan payments more manageable. The lower monthly payments can free up more room in your budget for other costs.
Lower Interest Rate
If interest rates decline or your credit score improved since you got your current auto loan, a refinance can help you secure a more favorable interest rate. Lowering your interest rate will lower your monthly payments and help you get out of debt sooner. Some borrowers get variable-rate loans, so their interest rate decreases if the index rate also decreases. However, variable-rate auto loans come with more risks than fixed-rate loans since they are less predictable.
Shorter Loan Terms
Some people want to get out of debt as quickly as possible. These people have enough money left over after each monthly payment and can shorten the duration of their auto loans through a refinance. While this strategy increases your monthly loan payments, you won’t have to worry about those payments for long. They will go away sooner than the monthly payments for your current loan. Shortening an auto loan also reduces the total interest you pay on the loan. This strategy embraces short-term sacrifice for long-term gain.
Tap Car Equity and Extra Money
Each monthly payment you make builds equity in your car. While cars don’t appreciate like houses, you still have some equity in your vehicle. You can conduct a cash-out refinance to tap into your car’s value and receive extra cash. You can use this money for anything. If you are planning a vacation, paying medical bills, or need the extra capital for anything else, an auto refinance can help.
Borrowers should assess how much cash they need before doing a cash-out refinance. It may be beneficial to obtain capital through another method, such as a personal loan or a home equity line of credit. Those resources can help you preserve your current auto loan while potentially getting better loan terms. If you are financing your car to raise extra cash, remember that you have multiple financial products that can help you achieve the same objective. Car owners with great loan terms should not conduct a cash-out refinance and should consider another route to raising funds.
What are the Risks of Auto Refinancing?
Auto refinancing is a useful option, but it has some risks. Knowing the risks in advance can help you decide if refinancing your auto loan makes sense.
You Might be Paying More in Interest
Extending your loan will reduce your monthly payments. However, prolonging the loan will increase the amount of interest you pay over the loan’s duration. Interest can accumulate if you become too reliant on refinancing your loans to reduce payments and extend loan terms.
Some people refinancing their auto loans get stuck with higher interest rates. If you got your loan refinanced before the Fed raised interest rates in 2022, refinancing would likely result in a higher interest rate. Some people feel like they have no other choice but to refinance their loans to reduce their monthly payments. Exploring additional income streams can make you less dependent on refinancing your car loan. However, it’s unavoidable for some borrowers who end up with higher interest rates.
There are Fees and Other Costs
Borrowers incur several costs for getting a new auto loan. Their current auto loan may have early payment penalties, and you will have to pay administrative fees and closing costs for your new auto loan. It’s not a seamless transition, and those fees and other costs can make a refinance unprofitable for some borrowers.
You May End Up Upside Down on the Loan
Some refinances can make you upside down on your current auto loan, meaning the loan’s principal exceeds your car’s value. You may have to take out gap insurance to protect yourself and the lender from the differences between the loan’s principal and your car’s actual value. Your car is less valuable now than when you picked it up at the dealership, so a cash-out refinance can realistically make you upside down on your loan.
How to Apply for Auto Refinancing
Applying for auto refinancing can help you see what terms and rates you can obtain. You can follow these steps to apply for a loan.
Evaluate Your Current Auto Loan
Your auto loan may not be as bad as you think. Some people are close to the finish line with their current loans or can manage the monthly payments if they pick up a side hustle. However, walking away from a loan may also become necessary to reduce costs, get a cash-out, or secure a lower interest rate.
Some borrowers also want to stop making auto loan payments. They want to get out of debt faster, and a shorter loan can help them. You should evaluate your current auto loan and your finances to see how refinancing your loan can help.
Review Your Credit
Lenders will look at your credit score to determine what interest rate and loan terms you can get. A higher credit score gives you more options, and it’s possible that you have improved your credit score since you got your first auto loan.
Borrowers should look for opportunities to catch up on existing debt and continue to make on-time payments. Increasing your credit score by a few points while you ponder getting an auto refinance can help you save money. Reviewing your credit and your financial obligations can reveal opportunities to improve your credit. You can find additional information on your credit report. Each of the three major credit bureaus — Equifax, Experian, and TransUnion — are required to give you one free copy of your credit report every year. Correcting any errors on your report can also bump up your score by a few points.
Shop Around and Get Rate Estimates
You don’t have to commit to the same lender for an auto loan refinance, and you might save extra money by looking around. Car owners can look for traditional banks, credit unions, and online lenders. Requesting quotes gives you more choices, and you may find a lender with a more reasonable credit score and debt-to-income requirements.
Requesting quotes will not hurt your credit score. When you apply for an auto loan, a hard credit check will take place. However, if you apply for many loans at the same time, you only incur one hard credit inquiry for all of that activity. It’s advantageous to reach out to several lenders and see what you can get.
Choose the Right Lender for Your Needs
You can shop around for auto loans, but it’s a good idea to know what you want before you get started. You may have to reach out to lenders that have lower credit score requirements. Other borrowers may benefit from reaching out to lenders who can give them lengthier loan terms. It’s also possible you need an auto refinance as quickly as possible. In that scenario, you may have better luck with an online lender than a traditional bank or credit union. Knowing what you want from an auto loan increases the likelihood of choosing the right lender for your auto refinance.
Prepare Documents and Other Requirements
Lenders will request several documents during the loan application process. Preparing these documents in advance will speed up the application process and let you get a new loan sooner. These are the documents you will have to provide, but some lenders may request additional information:
- Your driver’s license
- Proof of car insurance
- Proof of employment or income
- Previous bank account statements
- Proof of residence
- Your car’s registration paperwork
- Information about your current loan
Once you gather these documents, keep them in a safe place that is easy for you to remember. You may need to gather these documents in the future for another loan. Knowing where they are will save you time and help you get future loans approved sooner.
Prequalify (If Available)
Prequalifying for an auto loan can give you more confidence that you will get approved for the loan. This step doesn’t guarantee you will get approved. However, reassurance is useful since you have to incur a hard credit check regardless of whether you get approved or not.
Prequalifying for an auto loan refinance will not hurt your credit score. This process only involves a soft credit check. If you decide to apply for a loan offer to see if you can get it or not, you will incur a hard credit check.
Submit Your Application
After gathering the necessary documents and receiving multiple loan offers, it’s time to submit your application. The lender will guide you through the application process and should let you know about your status within a few days. You should periodically check your inbox while waiting for the application. The lender may send you a message requesting additional information or letting you know that you forgot to include a certain document. Responding to these types of messages promptly can speed up the process and lead to a quicker decision.
