When to refinance your car loan

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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 learn before you pull the trigger.

How auto loan refinancing can save you money

In general terms, refinancing is the process of replacing one or more existing loans with a brand-new one, typically through a different lender. The primary reason to consider refinancing is if you can qualify for a lower interest rate. For example, let’s say you have a 60-month loan with a 5.25 percent annual percentage rate (APR) on a $20,000 car. In this scenario, your monthly payment would be $380, and you’d owe $2,783 in interest over the five-year term.

Now, let’s say that you qualify for a 4 percent APR. This rate over 60 months would lower your monthly payment to $368 and your total interest charges to $2,100 — a savings of $683.

Of course, depending on where you are in the repayment schedule, your actual savings can vary. But the concept is the same: Qualify for a lower interest rate, and it can make your loan more affordable and save you money in the long run.

Use a car loan refinance calculator to run the numbers for your situation to see how much refinancing can save you.

When can you refinance your car loan?

Technically, you can refinance your car loan whenever you want, even shortly after you buy the vehicle.

The main thing to consider is whether your current auto loan has a prepayment penalty in place. If that’s the case, you may 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.

Just because you can refinance, though, it doesn’t necessarily mean you should. Some lenders charge a processing fee on refinance loans, which can eat into the potential interest savings. Also, if the chance of getting a lower interest rate is low, it may not be worth the trouble.

When is the best time to refinance your car loan?

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

  • Refinance car loan rates have gone down: Car loan interest rates often fluctuate based on the prime rate and other considerations. If you purchased your car a while ago, it’s possible that refinance 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. 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: Some dealers are willing to work with car buyers who have less-than-stellar credit and offer what’s called “buy-here, pay-here” financing. While this may seem like the only way you can get credit, there are some lenders that may be willing to work with you. What’s more, dealers tend to charge higher rates than banks and credit unions. Even if you get an indirect loan from a traditional lender through dealer-arranged financing, those interest rates may be slightly higher to compensate the dealer for handling the process. Refinancing directly with a lender later could allow you to score 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 at 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.

When is it a bad idea to refinance your car loan?

Refinancing your car loan doesn’t always make financial sense. 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: Remember that 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 there are no prepayment penalties.

How to refinance a car loan

Before you apply with a lender, shop around and compare interest rates and other terms from multiple lenders. 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, you can submit applications to multiple lenders. 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.

If you decide to move forward with a new lender, gather some 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 other information, including your car’s make and 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 they know where the car will be parked.

Does refinancing your auto loan hurt your credit?

There are a couple of ways refinancing your car loan can impact your credit: your recent inquiries and your length of credit history.

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

That said, both of these factors are much less important in calculating your credit score than your payment history. So unless you’ve applied for a lot of other credit accounts recently or you don’t have a long credit history, it’s unlikely to make much of a difference.

Options for refinancing your car loan

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.

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