Auto Loans

How to Refinance an Auto Loan

If you have previously borrowed money to purchase a car, you may have considered refinancing your auto loan. If done correctly, refinancing can save you money in the long term by reducing interest rates and shortening the length of your loan. You might also save money in the short term by negotiating a lower monthly payment.

Refinance an Auto Loan

While figuring out how to refinance a car may initially seem confusing, the process might only take an hour or so of your day. By comparing rates and following a few simple steps, your new loan should adequately reflect your current situation and reward you accordingly.  

How Does Refinancing a Car Work?

First, you must determine if refinancing your car is right for you. Consider a few key factors:  Has your credit score increased? Have market interest rates dropped? Next, consider your vehicle’s current value. Once you have determined that you should refinance, you’ll need to shop around for the best rates possible. Finally, you need to accept the new rate.

Why Refinance a Car Loan?

Refinancing your auto loan can help you in the following areas:

Lower Interest Rates

Market forces partially determine interest rates. If market rates have dropped since you took out your current loan, refinancing could result in a lower personal interest rate. You also may be eligible for a lower interest rate if your credit score has improved since first taking out a loan.

For whatever reason, it can be common not to get a favorable interest rate when initially taking out a loan. Whether due to a lack of preparation or spur-of-the-moment decision-making, it may be worth going back and renegotiating your deal at a later date. If your current interest rate is above market value, refinancing your auto loan and trading for a lower interest rate is your most effective means of saving money.

Decreased Car Payment

If your daily finances are feeling thin, you can add time to your loan to decrease the impact of your recurring payment. Remember that this will increase your repayment period and pay more interest over the long term. While not ideal, it may be the best option for borrowers on a tight budget.

Shorter Loan Terms

If you have more flexibility in your budget, shortening the loan terms as soon as possible is your most financially advantageous option. Refinancing may help shorten the loan length while keeping your monthly payment relatively the same as you’re used to. Even if you pay more monthly by refinancing, you save yourself a lot of money that would otherwise be spent on interest.

Under What Circumstances Should You Refinance a Car?

A lot can change in a person’s life in a short period after initially taking out an auto loan. Following certain personal developments, refinancing might be the best way to update the terms of your loan to your financial benefit.

Your Credit Score Increased

A credit score is an assigned number that predicts how likely you will pay back a loan on time based on your previous credit history. If you had a bad score when applying for a loan, you likely didn’t qualify for low rates. Your score has probably improved if you have been paying your bills on time. A better credit score makes you eligible for a lower interest rate.

Interest Rates Have Dropped

As mentioned previously, interest rates sometimes fluctuate in response to changes in the global economy. Refinancing your car while market rates are down can be a great way to get a better deal on your loan.

You Didn’t Shop Around for Rates Initially

You might have gotten a bad deal if you didn’t shop around rates when initially taking out your loan. Maybe you just needed your car in a hurry, or you got your loan from a dealership that jacked up interest rates out of convenience. Refinancing your car with a little more research at your disposal is a great way to cut your losses and start saving money.

Your Monthly Payment is Too High

If you took out your loan when any of the above-mentioned factors were not in your favor, you might be paying more every month than you feel you can easily afford. Refinancing for a lower interest rate might also result in a lower monthly payment.

Factors to Consider Before Refinancing a Car

It is essential to be cautious and consider every possible angle when refinancing your auto loan. Watch out for fees and penalties, and factor in the age and value of your vehicle. Refinancing isn’t your best option if your loan is “underwater,” meaning you owe more than your car’s current value.

Is There a Prepayment Penalty

A prepayment penalty is a clause in some loans that requires you to pay a fee for paying your loan off early. These are not always common, but they are worth looking out for because they could cost you money. These penalties lock you into your initial loan, deterring you from changing to a new lender. 

Pour over your loan documents before choosing to refinance. A prepayment penalty could make refinancing redundant and ultimately hurt you in the long run. If your car were stolen or totaled during the penalty period, you’d have to pay even more to free yourself from the loan.

What Fees Will You Be Responsible For?

While prepayment fees are the most discernible red flag in the loan process, there are various other potentially hidden fees to keep an eye out for when refinancing your vehicle.  

Depending on the situation, you may have to reregister and retitle your vehicle following a refinance. These fees vary depending on where you live, and you’ll want to look up your state’s fee rate before committing to a loan. Some lenders may even charge a simple application fee for refinancing a loan, though this is not always the case.

Is Your Loan Balance Higher Than the Value of Your Vehicle?

The value of your car drops considerably as soon as you drive it off the lot and can drop even further for various reasons. If your car has negative equity–meaning its market value is worth less than what you owe–you may have difficulty finding a new loan with favorable terms. Some lenders might even expect you to cover the difference before entering into a new loan.  

This scenario is sometimes referred to as “underwater” or “upside down” on a loan. Refinancing that loan will prove difficult and arbitrary if you are already underwater on a loan. One way to avoid going underwater on a loan is to pay 20% down at the time of purchase.

The Age of the Vehicle

Before you attempt to refinance, you’ll want to factor in the age of your car and the miles that may have piled up over the years. If your car is more than a few years old or has high mileage, you may not be able to refinance. Lenders tend to have age and mileage restrictions when considering a new loan. The same can be said for newer vehicles with recent loans because the new loan may still be higher than the vehicle’s value.

How To Refinance Your Car Loan

Considering all the factors mentioned above and choosing to go ahead with refinancing your car loan, the process shouldn’t take much more than an hour of your time. Follow these steps in order, and you should see a better opportunity right away:

Prepare Your Paperwork

Refinancing a vehicle is similar to any other application procedure. You will need to verify your identity, creditworthiness, and your car’s value. It is best to have the following related documents organized and on hand:

  1. Personal information: This may include your driver’s license, current and previous addresses, your social security number, current employment details, and how much you pay monthly in rent or toward your mortgage.
  2. Proof of income: Lenders will need to know if you are working and how much you’re earning to assess your ability to pay off your next loan properly. Try to dig up previous tax returns, paycheck stubs, utility bills, and bank statements to help prove you are financially responsible.
  3. Evidence of auto insurance: Not only is it illegal not to carry auto insurance, but lenders will need to see that you are adequately covered and reimbursed in the case of an accident. Prepare a copy of your up-to-date insurance card and proof of registration.
  4. Information on your current loan: Find evidence of a recent payment on your current loan. Make sure you know your monthly payment and the remaining balance, the amount of time left to pay off the loan (often called the loan term), the interest rate you’re paying, and the customer service number of your current lender.
  5. Information about the car:  Your new lender needs to know everything about your vehicle. Make sure to know the make, model, model year, mileage, and VIN.

Review Your Current Loan

Remember why you are refinancing in the first place, and pick through your current loan for negative aspects you won’t want in your new loan. Know exactly how much interest you have been paying, your monthly payment, and what the ultimate cost of the loan will be once you finish the term. This information will help ensure you are saving money with a new lower rate.

Estimate the Value of Your Car

You’ll want to ensure your car’s value is higher than what’s left on your current loan. Lenders might not be willing to work with you if you are already “underwater” on a loan. Kelley Blue Book is a quick and straightforward way to get an accurate estimate on your car, and seen as a legitimate resource by most lenders.

Shop Around for the Best Refinancing Rates

Interest rates can vary, so it is crucial to shop around between lenders before making a final decision. Start with your bank, ask about possible discounts for existing customers, and then contrast their rates to what other financial institutions offer.  

Estimate How Much You Would Save

Doing the math in advance will help clarify how much you might save in terms of interest, your monthly payment, or both. Use an auto loan calculator to see if you are saving more money on your new loan when compared to your current loan.  

Apply or Prequalify for Financing

Once you are ready, get prequalified with at least three lenders. This practice is a type of soft inquiry that may not affect your credit score and will provide you with multiple offers to compare and choose from without committing. Pick the offer that best suits your needs, then submit a final loan application with all the previously listed personal documents included.

Accept the Offer

Most offers stand for about a month before expiring, so you’ll have a little time to think things over. Once you’re ready, sign the new loan agreement. Your lender will likely take the reins from there and pay off your old loan directly. A new loan will be generated with new terms and a new interest rate. You can typically start making payments on this new loan within 30 days.