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What happens when you refinance a car loan & tips to follow

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Woman puts bags in the back of her car
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Refinancing is the process of replacing an existing loan with a new one, typically through a different lender. Most people will use it to reduce their monthly payment — either by getting a lower rate or extending their loan term.

In general, refinancing is a good idea if it allows you to save money on interest over the course of your loan. But it’s not for everyone, so consider it carefully before you apply.

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. 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 with just a soft credit inquiry, which won’t impact your credit score. Once you have preapproval, 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 if fees will impact your 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 in interest. If that is the case, refinancing your auto loan won’t be worth it.

Some lenders also charge a big 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.

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. Look into more lenders

When you first borrowed money to buy a car, it may have been through dealer-arranged financing. However, many banks, credit unions and online lenders offer direct financing to car buyers and owners. Just make sure your current car and auto loan meet the lenders’ requirements. Most have set maximums on mileage and vehicle age alongside a minimum amount you need to borrow to qualify.

In general, it is best to start with the financial institutions you already work with. In some cases, you may qualify for a loyalty discount based on your existing relationship with the bank or credit union.

Don’t stop there, though, even if the terms are excellent. Take some time to compare that quote with rate offers from other banks and lenders. This process can take some time, but the more options you compare, the higher your chances will be of getting the best auto loan terms available to you.

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. There are a few situations where refinancing makes the most sense.

  • Refinance when auto rates have gone down. Most car loan interest rates fluctuate based on the prime rate and other factors. If you purchased your car a while ago, it is possible that car loan rates have decreased since then.
  • 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. If you have improved your credit score since signing up for your initial loan, you may qualify for better loan terms.
  • 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 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 term. But while your monthly payment will be lower, expect to pay more in interest.

Requirements to refinance

Lenders determine eligibility differently. Before you refinance, check the requirements for you, your vehicle and your current loan.

  • A regular source of income, a low debt-to-income ratio and good credit are the basics. But a lender may also want to see proof of residence, such as a lease agreement, mortgage statement or utility bill, to make sure that they know where the car will be parked.
  • Lenders will want to know your car’s make, model, year, vehicle identification number (VIN) and mileage. This will help the lender determine how much your car is worth and whether it is worth it to refinance based on your loan amount.
  • Your loan current balance, monthly payment and payoff amount will let the lender determine how much you need to borrow and if you meet its minimum loan requirements.

When refinancing doesn’t make sense

Refinancing your 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.

Being upside-down on the original loan will also make it difficult to refinance. Lenders typically won’t approve you if you owe more on the car than it is worth. This is also known as being “underwater” on the loan — and it is a tough spot to get out of.

If your car is older or has quite a few miles on it, lenders may not want to refinance. 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.

Next steps

The primary reason to consider refinancing is if you can qualify for a lower rate and will save money in the long run. Technically, you can refinance your car loan whenever you want, even shortly after you buy the vehicle.

But depending on where you are in the repayment schedule, your actual savings will vary. Use a car loan refinance calculator to run the numbers for your situation to see how much refinancing can save you.

Learn more

Written by
Rebecca Betterton
Auto Loans Reporter
Rebecca Betterton is the auto loans reporter for Bankrate. She specializes in assisting readers in navigating the ins and outs of securely borrowing money to purchase a car.
Edited by
Student loans editor
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