How to Refinance a Car Loan With Bad Credit
Lenders typically avoid taking on borrowers with low credit scores because they’re considered high-risk and less likely to repay their loan. Therefore, if you have a credit score lower than 670, you may have trouble finding a lender to refinance your car loan.
However, if you have bad credit, you are not necessarily stuck in that situation permanently. There are a variety of steps you can take to improve your score and get better rates on auto loan refinancing, including:
- Take steps to boost your credit score
- Review your credit score and report
- Check your lender’s refinancing criteria
- Shop and compare other options
- Gather necessary documentation and information
- Make your selection and apply
- Receive approval and close on the new loan
So, while figuring out how to refinance a car loan with poor credit may initially seem overwhelming, it’s best not to get discouraged. By taking some time to follow a few simple steps, you can ultimately save yourself money in the long run.
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Why Refinance Your Auto Loan At All?
The primary goal of refinancing an auto loan is to get more favorable terms that make the loan cheaper or easier to manage. This is possible because people’s financial situation often changes over time.
For example, if you had a 550 credit score when you received financing for your vehicle, you probably received a loan with high interest. Two years later, your credit score improved to 700. Because you now have better credit, you could qualify for lower interest rates and ultimately pay a lower total amount for your vehicle. However, you would need to refinance your loan to access those rates.
However, it’s not just interest rates that are dictated by your financial history. Your personal circumstances also dictate the length of the loan and size of the premiums. Therefore, refinancing potentially provides the following mechanisms to realize savings:
- Lower Interest Rates: Car loan rates are driven by two main factors: Your credit score and the borrowing interest rates set by the Federal Reserve. If you’ve improved your credit since taking out your existing car loan, you may be eligible for a lower interest rate by refinancing. In addition, if federal interest rates have come down since you got your initial loan, the refinancing will reflect those changes too.
- Lower Monthly Premiums: If your current car loan payment is too large for your budget, refinancing may help relieve some of your financial burdens. But remember, lower monthly premiums typically mean longer loan terms and paying more interest over the life of the loan. Nevertheless, refinancing your car loan could provide short-term financial relief and prevent you from falling behind on payments, ultimately lowering your credit score.
- Shorter Loan Terms: If you have more disposable income to allocate toward your car payments, you could refinance your car loan to shorten the loan term and lower your overall interest payments. While your monthly premium may increase, you’ll likely pay less interest over the long term.
Why Is It Challenging To Refinance When You Have Bad Credit?
It can be challenging to refinance when you have bad credit because lenders typically consider you a higher credit risk. Bad credit signals to lenders that you may have a history of late or missed payments, defaulting on loans, or having high debt levels. These factors increase the likelihood that you may default on the refinanced loan, and the lender may lose money.
As a result, lenders may be less willing to offer you favorable loan terms, such as a lower interest rate, longer loan term, or lower monthly payments. Alternatively, if a lender is willing to refinance your auto loan, they may require a co-signer with good credit or collateral, such as a home or other asset, to secure the loan.
The Steps to Refinancing an Auto Loan With Bad Credit
If you have less-than-ideal credit and you are looking to refinance, take the following steps the maximize your savings potential:
1. Take Steps to Boost Your Credit Score
Before refinancing your car loan, take the time to boost your credit score to improve your odds of receiving more favorable terms. The FICO scores that most lenders use range from 300 to 850. If your score falls below 670, it’s considered less-than-ideal. Here’s a close look at the FICO score tiers:
- Poor: 300 – 579
- Fair: 580 – 669
- Good: 670 – 739
- Very Good: 740 – 799
- Exceptional: 800 – 850
The primary factors that affect your credit score include payment history, credit usage, length of credit history, credit mix, and new credit. To improve your creditworthiness, focus on these underlying factors that affect your scores. Here’s what you can do:
- Make your debt payments on time: Late payments can hurt your credit score and will look bad on your credit report.
- Keep your credit utilization low: Credit utilization is the ratio of a borrower’s credit card balances to their credit card limits, expressed as a percentage. Credit usage below 30% is considered optimal for refinancing.
- Maintain a healthy credit mix: A healthy credit mix typically includes a variety of credit accounts, such as credit cards, auto loans, mortgages, and personal loans, with a good payment history and manageable debt levels.
- Only apply for credit when needed: Each application for a line of credit triggers a “hard pull” of your credit, which can temporarily reduce your credit score by up to 10 points.
Remember, every little bit helps. Even if your improved credit score does not move you into the next tier, a higher credit score can still give you a better chance for loan approvals, lower interest rates, higher borrowing limits, and more negotiating power.
2. Review Your Credit Score and Report
Next, review your credit score and report to know where you stand regarding your credit health. Under federal law, you’re entitled to a free annual credit report from the three major consumer credit bureaus, Experian, Equifax, and TransUnion. Head to annualcreditreports.com to request your free copies.
Once you have your credit report, review it carefully for errors such as incorrect personal information, inaccurate payment history, outdated balance, or inaccurate date of last payment. If you notice any mistakes, file a dispute with the credit reporting agency.
Note that credit reports from the three credit bureaus do not usually contain credit scores. To check your credit score, contact your credit card company, or visit free credit scoring sites.
3. Check Your Lender’s Refinancing Criteria
Though refinancing requirements may vary depending on the lender, here are some common ones to be aware of, especially if you have bad credit:
- Debt-to-income ratio: Your debt-to-income ratio measures how much of your monthly income goes to paying debts. An acceptable DTI ratio for auto loan refinancing varies from lender to lender, but it’s usually around 30% or below.
- Credit score: Most lenders have minimum credit score requirements for auto loans, with a score of 660 providing standard rates. However, some lenders will still provide loans at a lower threshold.
- Your payment history: The payment history of your various LOCs can indicate whether you have a record of paying your bills on time.A robust payment history can increase a borrower’s chances of approval and may lead to more favorable loan terms and interest rates.
The type of car you own may play a role too. Some lenders may have restrictions on the age, mileage, and value of the vehicle. Generally, newer and more valuable cars may be easier to refinance, while older or high-mileage cars may be more difficult to refinance or may result in higher interest rates.
4. Shop and Compare Other Options
Shopping around for refinancing allows borrowers to compare offers from multiple lenders, which can help them find the best interest rates, loan terms, and fees. By doing so, borrowers can potentially save money and improve their overall financial situation.
Here are a couple of things to look out for:
- Eligibility criteria: Some lenders may have stricter requirements regarding credit score or vehicle age, while others may be more flexible. To save time and energy, focus on lenders whose eligibility requirements you can meet.
- APR: The starting APR (Annual Percentage Rate) is the yearly percentage of your loan’s fees relative to the principal. This includes interest and other associated fees such as origination, processing, and application fees. Make sure to audit which fees make up the APR and compare them to other lenders so you do not choose a loan with more fees than necessary.
- Estimated refinance loan rate: The estimated refinance loan rate is the new interest rate a lender might offer based on your credit profile, income, vehicle details, etc. Therefore, it’s crucial to scrutinize multiple lenders to find the best deal.
- Customer support: When choosing lenders, evaluate their customer support services and ensure they have representatives you can reach when you need them. Look for lenders that offer service via phone or online chat.
- Whether online prequalification is available: Getting prequalified for auto loan refinancing can help borrowers understand their potential loan options, including the amount they can borrow, the interest rate, and the loan terms. This can also allow borrowers to compare offers from different lenders and potentially negotiate better loan terms.
5. Gather Necessary Documentation and Information
Applying for an auto loan refinance is similar to applying for a regular auto loan. You’ll typically need to provide the following:
- Personal Information: Borrowers typically must provide personal information such as their name, address, and Social Security number.
- Evidence of Auto Insurance: Prepare a copy of your insurance card and proof of registration.
- Proof of Income: You’ll need your previous tax returns, bank statements, pay stubs, etc.
- Current Loan Information: Your monthly payment, interest rate, and time left to pay off the loan.
- Vehicle Information: The make, model, age, and mileage of the car.
6. Make Your Selection and Apply
Getting prequalified for a loan can be beneficial as it allows borrowers to know the maximum loan amount they can get, the interest rate, and the loan terms before applying. This can help borrowers make informed decisions, save time and potentially negotiate better loan terms.
7. Receive Approval and Close On the New Loan.
Loan offers are generally valid for 30 to 60 days, depending on the lender. Once you’re ready, review the loan agreement and ensure the numbers match your agreement. If everything looks good, sign the agreement to close on the new loan.
What Happens to Your Old Loan?
After refinancing, your lender will typically pay off your existing loan and generate a new loan with new terms and rates. Depending on the lender’s policy, you may start paying for the new loan within 30 days.
When to Refinance Your Auto Loan With Bad Credit
In some cases, refinancing your auto loan may not be the best move and could cost you more in the long run. Before diving headfirst into refinancing, assess whether your circumstances actually warrant it.
Consider Refinancing If…
- Your credit has improved significantly, even if it’s still poor: With better credit, lenders may now view you as a lower-risk borrower, giving you access to more favorable interest rates. Therefore, even if your credit score is still less-than-ideal, it may be worthwhile to refinance and take out a new loan that reflects your current situation.
- You need better loan terms to keep up with payments: Refinancing could provide better, more manageable terms if you’re struggling to keep up with your current loan payments.
- Interest rates have dropped: As mentioned previously, interest rates set by the Fed can affect the cost of taking out an auto loan. If interest rates have dropped since you took out your current loan, refinancing could lead to savings.
- You did not get the best offer: If you did not shop around for the best offer when you applied for your current auto loan or got it directly from a car dealership, it might be worth shopping around for better loan terms.
- Your car’s equity has increased: Lenders typically prefer cars with higher equity because the more positive equity in your car, the more lenders can make when they sell the vehicle if you default.
Do Not Refinance Yet If…
- Your credit score has not changed or has gotten worse: If your credit score has not improved, refinancing will likely result in an unfavorable interest rate that could cost you more in the long run.
- You do not have much time left on your loan term: Interest is typically front-loaded, which means you’re paying more interest in the early years of a loan term. If you refinance near the end of your loan term, you may not save much on interest charges.
- The fees outweigh the benefits: Some lenders charge a prepayment penalty if you pay off your loan early to recover the interest payments they would have otherwise received. Prepayment penalties can be up to 2% of the outstanding balance on your current auto loan. Check with your lender to see if there are any fees associated with refinancing and see if you can afford them.
- Your car is old and has high mileage: Even if you have good credit, most lenders will not refinance cars older than ten years or have more than 100,000 miles on them.
- You want to apply for more credit in the near future: Refinancing your car loan generates a hard credit inquiry and could temporarily lower your credit score. If you plan to apply for a mortgage or other credit soon, consider holding off on an auto loan refinance to keep your FICO score high.
Options If You Cannot Find Refinancing Approval
If you do not meet any lender criteria or are denied auto refinancing, consider the following to improve your chances of getting approved.
Bring On a Co-signer
A co-signer can help you become eligible for a refinance loan if your credit score is too low. However, the co-signer must have good credit and be willing to take responsibility for the loan in case of default.
Wait Until Your Credit Improves
If you cannot find an auto refinance loan with favorable terms due to your low credit score, consider waiting until your credit improves significantly. In the meantime, take steps towards improving your credit, such as paying off outstanding debts and maintaining a low credit usage ratio.
Ask About Payment Assistance Options
If you’re having difficulty making your expensive car payments and can not refinance, ask your lender if they offer payment assistance programs to help you make payments on the loan and avoid repossession. To be eligible for payment assistance programs, you may need to provide documentation to prove your hardship, like bank statements or recent pay stubs.
Sell Your Car and Pay Off the Loan
Selling your car to pay off your existing loan is the worst-case scenario. However, if you’re unable to keep up with your current car loan and it’s negatively impacting the other aspects of your life, getting rid of your vehicle to repay the loan in full may be the only option.
What This Means For You
Refinancing an auto loan with bad credit can be challenging, but it is not impossible. By researching different lenders, improving credit scores, and working with a co-signer, borrowers with bad credit can potentially find better loan terms and save money on their car payments.
However, it is essential to carefully consider the costs and benefits of refinancing and ensure that the new loan fits within one’s budget and financial goals. With the right approach and careful planning, refinancing can be a powerful tool for improving one’s financial situation and getting back on track to financial success.