Refinancing your car loan: 4 things you need to know

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Refinancing is the process of replacing one or more existing loans with a brand-new one, typically through a different lender. Deciding when to refinance your car loan requires you to consider several variables, including current interest rates, your credit score, the terms of your existing loan and more. In general, refinancing is a good idea if it allows you to save money in interest over the course of your loan.

If you’ve recently received an offer to refinance your car or you’re simply looking to learn how to refinance a car loan, here are some things to know first.

When should I refinance my car loan?

The best time to refinance your car loan is when it can save you money in the long term, but it may also help if you’re hoping to catch a break on your monthly payments. Here are a few situations where it may make sense to refinance:

  • Refinance car loan rates have gone down: Most car loan interest rates fluctuate based on the prime rate and other considerations. If you purchased your car a while ago, it’s possible that car loan rates have decreased since then.
  • You’ve improved your credit score: Even if market rates haven’t changed, improving your credit score may be enough to get a lower rate. The better your credit, the more favorable loan terms you’ll receive. If you’ve improved your credit score since signing 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. If you took out your initial loan through dealer-arranged financing, refinancing directly with a 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 (from 36 months to 48 months, for instance). Keep in mind, though, that while you will pay less per month with this strategy, you can expect to pay more over the life of the longer loan.

Tips when refinancing your car loan

Timing isn’t the only factor to consider when it comes to refinancing your auto loan. Below are some tips to follow when it is time to refinance.

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 some cases, you may be able to get prequalified before you submit an application and receive a rate quote with just a soft credit inquiry, which won’t impact your credit score.

If there’s no prequalification tool, 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 to 45 days.

With rate quotes in mind, you’ll be able to calculate how much refinancing can save you and if it’s worth it.

2. Consider fees

Before refinancing, consider whether fees will impact your overall savings. For instance, your current auto loan may have a prepayment penalty in place. If that’s the case, you’ll have to pay money to the original lender when the new one pays off the debt. You can check the contract you received from the dealer to find out if there’s such a penalty.

Some lenders also charge a processing fee on refinance loans, which can eat into the potential interest savings.

3. Understand how your credit will be impacted

Virtually every time you apply for credit, the hard inquiry will reduce your credit score by a few points. If you then open a new loan account, it’ll lower the average age of your accounts, which can also lower your credit score.

That said, both of these 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’ve applied for a lot of other credit accounts recently or you don’t have a long credit history, refinancing is unlikely to make much of a difference.

4. Look into multiple types of financing

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.

In general, it’s 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.

Requirements to refinance

If you decide to move forward with a new lender, there is some required information that you should have prepared. Gather information about your existing loan, including the loan balance, monthly payment and payoff amount — the last one is the current loan balance plus any interest that has accrued between your last payment date and the day the loan will be paid off.

You’ll also need to provide potential lenders with 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’s worth it to refinance based on your loan amount.

Finally, you’ll need to prove your ability to repay the loan, which requires documentation of your employment and income. Some lenders may also require 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.

You also should prepare to share your credit score, income details and auto insurance information. You’ll typically have the best chance of qualifying for a loan with a credit score above 600 and a debt-to-income ratio below 50 percent, although there are plenty of lenders that accept borrowers outside of this range.

Mistakes to avoid when refinancing your auto loan

Refinancing your car loan doesn’t always make financial sense. The main mistake you can make when it comes to refinancing is timing. If any of the following scenarios apply to you, it may be worth it to stick with your current loan.

  • You’re far along in your original loan’s repayment: Through the amortization process, your interest charges gradually decrease over the life of the loan. As a result, a refinance has more potential to save money when you’re in the earlier stages of repaying the original loan.
  • Your odometer is hitting big numbers: If you’re driving an older car with high mileage, you may be out of luck. Most auto lenders have minimum loan amounts and won’t find it worthwhile to issue a loan on a car that has significantly depreciated in value.
  • You’re upside-down on the original loan: Lenders typically avoid refinancing if the borrower owes more than the car’s value (also known as being “underwater”).
  • Your current loan has a prepayment penalty: Some lenders charge a penalty for paying off your car loan early. Before you refinance your loan, investigate the terms of your existing loan to make sure that there are no prepayment penalties.

Next steps

The primary reason to consider refinancing is if you can qualify for a lower interest rate and 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 can vary. You can 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