What happens when you refinance a car loan & tips to follow
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Refinancing involves replacing an existing loan with a new one, typically through a different lender. Most people will use it to reduce their monthly payments — either by getting a lower rate or extending their loan term.
Refinancing is generally a good idea if it allows you to save money on interest. But it’s not always a wise financial move, especially as interest rates continue to rise, so think carefully before applying.
4 tips to follow when refinancing your car loan
Refinancing is a great way to save money on interest and potentially lower your monthly payment. Take your time comparing lenders and finding a good deal — it could mean bigger savings down the road.
1. Shop around
Before you apply with a lender, shop around and compare interest rates and terms from multiple lenders. Explore big banks, credit unions and online lenders for the best deal on auto loans. All lenders have their own formulas for calculating your rate, so getting more than one quote is important.
In most cases, you can get preapproved before you submit a full application and receive a rate quote without impacting your credit score. Once you have preapproval from several lenders, you can select the best offer and complete the refinancing process.
If there’s no preapproval option, keep your applications within a short time frame. The multiple inquiries that show up on your credit report will be combined into one when calculating your credit score as long as they all occur in a short period, typically 14 days.
2. Consider fees
Before refinancing, consider whether fees will impact your overall savings. Some auto loans have a prepayment penalty in place, which means paying off your loan early can cost you more than you would save by reducing the interest rate.
Some lenders also charge a substantial origination fee when you take out a loan to refinance. Like a prepayment penalty, it can eat into the potential savings and make refinancing more of a hassle than just sticking with your current lender.
Both your old and new lender may charge transaction fees, covering administrative or processing costs for terminating the old loan and starting the new loan agreement. You may be able to negotiate these fees. Some states will charge you state registration and title transfer fees for re-registering your car following refinancing.
3. Understand how your credit will be impacted
Virtually every time you apply for credit, a hard inquiry will reduce your credit score by a few points. If you then open a new loan account, it will lower the average age of your accounts, which may also lower your credit score.
That said, both factors are much less important in calculating your credit score than your payment history — and making timely payments on your new loan will increase your score over time. So, unless you have applied for other credit recently or you don’t have a long credit history, refinancing is unlikely to make much of a difference.
4. Check where you already have an account
Start your search for refinancing with financial institutions you already have relationships or accounts with. There are many benefits to this approach.
You may qualify for a loyalty discount on some loan fees due to your existing relationship with a lender, bank or credit union. If your financial institution knows you consistently make payments on time or maintain positive balances in your accounts, it can increase your chances of getting approved for refinancing.
Alternatively, if your credit score is on the low side, a lender with whom you already have a relationship may still be willing to work with you and provide refinancing.
When should I refinance my car loan?
There is no best time to refinance your car loan — if it saves you money, it is a good time.
To illustrate, assume the remaining balance on your auto loan is $18,000, the current monthly payment is $450, and you have four years remaining on the loan term. You get approved for a four-year auto loan, but the interest rate will be 5 percent instead of the 8 percent you’re currently paying. Your monthly payment will drop to $414.53, and you’ll save $1,702.69 in interest over the life of the loan by refinancing.
There are a few situations where refinancing makes the most sense.
- Auto rates have gone down. Most car loan interest rates fluctuate based on the prime rate and other factors. Though interest rates are currently trending upward, depending on when you purchased the car, you may still be able to find a slightly lower rate.
- You have improved your credit score. Even if market rates haven’t changed drastically, improving your credit score may be enough to get a lower rate. You may qualify for better loan terms that will reduce your out-of-pocket costs.
- You got your initial loan from the dealer. Dealers tend to charge higher rates than banks and credit unions to make a bigger profit. If you took out your initial loan through dealer-arranged financing, refinancing with a different lender could get you a lower rate.
- You need lower monthly payments. In some cases, refinancing a car loan may be your ticket to a more affordable car payment, with or without a lower interest rate. If your budget is tight and you need to reduce your car payment, you could refinance your loan to a longer repayment term — but expect to pay more in interest because you are extending the loan.
When refinancing doesn’t make sense
Refinancing a car loan isn’t always the right choice. If you are close to paying off your loan, refinancing may not save you money. Just stick with it unless you desperately need to extend your loan term to reduce your monthly payment.
Lenders typically won’t approve you if you owe more on the car than it is worth. This is also called being “underwater” or upside down — and it will make it hard to refinance.
Lenders may not want to refinance if your car is older or has quite a few miles on it. This usually looks like a vehicle that is 10 model years old or has more than 100,000 miles, although the specifics vary by lender.
Finally, with interest rates on the rise, you may pay more by refinancing in the current market environment. The Federal Reserve has been working to control inflation by increasing the federal funds rate, which in turn causes interest rate increases on everything from credit cards to car loans.
The average APRs for new and used vehicles were 5.16 percent and 9.39 percent, respectively, as of 2022’s third quarter, according to Experian.
Requirements to refinance
Lenders determine eligibility differently. Before you refinance, check the requirements for you, your vehicle and your current loan. Most lenders will require:
- A regular source of income, a low debt-to-income ratio and good credit
- Proof of residence, such as a lease agreement, mortgage statement or utility bill
- Your car’s make, model, year, vehicle identification number (VIN) and mileage to evaluate your car’s worth
- Your loan’s current balance, monthly payment and payoff amount to determine if you meet its minimum loan requirements
In most instances, you’ll also need to have made at least six payments on the loan and have at least six months remaining on the loan term to refinance. Lenders also have minimum and maximum balance thresholds to be eligible for refinancing — typically between $3,000 and $50,000.
Furthermore, the car should be no more than 10 years old — some lenders limit the maximum age to 8 — and the mileage should not exceed 100,000 or 150,000, depending on the lender.
The bottom line
The primary reason to consider refinancing is if you can qualify for a lower rate and will save money in the long run. Consider how much longer you have on a loan before proceeding with a refinance. Depending on where you are in the repayment schedule, your actual savings may not be that significant or worthwhile. Use a car loan refinance calculator to see how much refinancing can save you.
If refinancing is too expensive, you still have options. You could be better off requesting a car loan modification with your lender if your car payments are stretching your budget too thin or you’re experiencing financial hardship.