What is auto loan refinancing? How it works and when it’s smart

If you’ve owned your car for a year or more, lenders may advertise better interest rates than you’re being charged. Lower interest rates offer the possibility of saving on your monthly payments. To get a lower rate, consider auto refinancing. What is auto loan refinancing? Essentially, it’s getting a new loan for your car.

Refinancing could be a good option if you have good credit — especially if your credit has improved since you first took out the loan. If you have a poor interest rate due to financing with a dealership, you may find better rates even without excellent credit.

It’s important to understand the process and compare refinancing rates before applying.

How does refinancing a car work?

When you refinance your car, you take out a new auto loan to pay off an existing car loan. The new loan will likely come with a different interest rate and term. You will pay the new lender in fixed monthly installments as you did with the old lender.

Refinancing could reduce your interest rate, lower your monthly payments and enable you to pay off the debt quicker. But this depends on your credit status and the rate you qualify for.

How to save money with your auto loan refinance

There are a few ways to save money when refinancing your auto loan.

Lower your interest rate

You might get a lower interest rate with a new lender. This is more likely if you have a good credit score and equity in your car. With a lower interest rate, the cost of borrowing money will be less over the life of the loan. This could save you hundreds or thousands of dollars.

Lower your monthly payments

Refinancing your auto loan may lower your monthly payments. You could reduce your payments with a better interest rate or by extending the loan term. However, increasing the loan’s length without lowering your rate will increase its overall cost. You’ll pay more in interest.

When is it a good idea to refinance your auto loan?

Refinancing your auto loan may be a good idea if one of the following is true of you:

• Your monthly payment is too expensive.
• Your credit score has improved since you received your loan.
• You financed through a dealership and see other lenders offering better rates.
• Your vehicle has positive equity.

Some circumstances could prevent you from refinancing or make it a bad option. You may want to hold off if:

• Your car’s mileage exceeds 100,000, the vehicle is over 10 years of age or you fail to meet other refinancing requirements.
• You’re upside-down on your loan.
• You’ll incur prepayment penalties for paying your loan off ahead of schedule that exceed potential savings.
• You’re almost done paying off the loan, and refinancing means you’ll pay more in interest.
• You’ve already refinanced your car loan recently.
• Your credit score is too low to qualify.
• You’ll get a higher rate if you refinance due to rising market rates or other factors.

How to refinance your car loan

Understanding the process of auto loan refinancing is just as important as knowing the benefits. Here are four steps to follow when refinancing a car loan.

1. Check your credit score and report. The auto loan rate you receive will depend upon your score. A credit score over 670 is ideal.
2. Compare rates and prequalify with several lenders to save your credit from taking multiple hits.
3. Apply online, over the phone or in person and review the terms before signing.
4. Pay off your current loan with your new loan. Continue paying your existing loan until you verify it’s completely paid off. Any excess payments will be refunded.

The bottom line

Refinancing your auto loan may help you save money over the life of the loan. This option is worth considering if interest rates are lower or your credit has improved. But if lowering your monthly payments would require extending your loan term, you may want to look into refinancing alternatives.