Are your car loan payments stretching your budget thin? You may have considered refinancing to lower your payment or possibly get a lower interest rate. But if your credit score is low, it may not be a smart move — you should likely consider alternatives instead.
Why you shouldn’t refinance a car loan with bad credit
The lender starts a new loan term when you refinance your auto loan. In turn, you could get a more affordable monthly payment. But there’s a catch: Unless your credit score has improved since you took out the original loan, you likely won’t get a better interest rate. Even worse, you could pay several hundred or thousands of dollars more over the life of the loan since the lender will have more time to collect interest from you.
It’s equally important to determine if your current lender charges prepayment penalties. If so, the drawbacks of refinancing your auto loan could outweigh the benefits of a lower monthly payment.
How to refinance a car loan with bad credit
If interest rates have decreased since you purchased your vehicle, or you absolutely need a lower payment, refinancing could be worthwhile.
Check your credit
Review your credit report and score to avoid any surprises before you start shopping for a new loan. If you notice any inaccurate or outdated information, file disputes promptly with the credit bureaus — Experian, TransUnion or Equifax — reporting the incorrect data.
You can request a copy of your credit report for free using AnnualCreditReport.com. Typically checking your credit report can only be done through it for free once a year, however, in response to the COVID-19 pandemic, weekly reports are available.
Explore your options
You can check with your existing lender about refinancing options that may be available to you. Since most lenders don’t refinance their own loans, you would request this in the form of a loan modification.
Also consider options from banks or credit unions you currently do business with. Online lenders that cater to consumers with less than perfect credit may also be an option. Depending on the lender, you may be able to check your rate without affecting your credit score.
Apply for a new loan
Before submitting a loan application, gather any documents the lender will need to expedite the review process. Most will request proof of income, residency and information about your current loan. You will also need to provide the mileage, make, model and vehicle identification number for your car.
When you apply, be sure to accurately complete the forms. The lender will usually confirm the information you provide. Any discrepancies could result in the denial of your loan application.
Finalize the loan
Review the loan documents to ensure the terms and conditions work for you. If so, sign on the dotted line to finalize the transaction. The funds will either be sent directly to your current lender, or to you so that you can pay the original loan off.
How to boost your credit before refinancing
It’s in your best interest to improve your credit score before refinancing your car loan. The most competitive interest rates are generally reserved for borrowers with good or excellent credit, and a higher credit score could mean the difference between getting a 5 percent or 19 percent interest rate.
Here are some practical ways to improve your credit score:
- Pay all your bills on time.
- Get current on any past-due debts.
- Reduce the balances on your credit cards to at least 30 percent of your credit limit.
- Don’t close old credit accounts.
- Only apply for new credit as needed.
You should also monitor your credit score to track your progress.
Alternatives to car loan refinancing
There are other options available if you run the numbers and decide that refinancing your car loan isn’t a smart financial move. Depending on what your car is worth and how much is owed on the current loan, you could trade it in for a more affordable option and possibly roll the outstanding balance into a new loan.
But if you are upside down on your current loan, consider adjusting your budget in the short term to make the payments more affordable until you qualify for a refinance. You should also improve your credit score in the meantime so you will be in the best position to get a better interest rate when you apply for a new loan.
The bottom line
Unless you’re experiencing financial hardship and risk having your car repossessed if you can’t lower the payments, refinancing with bad credit may not be a healthy financial decision. Instead, explore alternatives, like adjusting your spending plan temporarily until you get your finances and credit health back on track. Or you may be able to trade your car in for a more affordable ride, depending on how much it’s worth.
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