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When to refinance your car loan

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Refinancing your car loan entails swapping your current loan for a new one with different terms. But maybe you are wondering if it is a good time to refinance or if you should hold off. Before deciding, you will need to review the lender’s requirements and determine if it charges prepayment penalties. It is equally important to consider the amount of time remaining on the loan term, your credit score and overall financial health.   

When you should refinance your car loan 

If you refinance your car loan, you will likely lower your monthly payment and could save on interest. Keep these factors in mind when deciding if it makes sense for your financial situation.    

You need to change your monthly payment

If your income has decreased recently, or you want to free up funds to meet other financial goals, it could be time to refinance your car loan to get a lower monthly payment. 

When you refinance, you either increase your loan term or find a lender with a lower interest rate. Refinancing at a lower rate is ideal — it will save you money overall and will likely reduce your monthly costs. 

But if you take on a longer term to lower your payment, you will pay more interest over the life of your loan. Refinancing could still be the right move for a lower monthly payment, but it could still cost you more. 

Your credit score increased 

The best interest rates on auto loans are generally reserved for buyers with good or excellent credit — typically a score of 670 or higher.  

So, if you took out a loan at a higher rate and now have better credit, you could qualify for an auto loan with more favorable terms. It isn’t guaranteed, but borrowers with good to excellent credit may qualify for rates in the 3 percent to 5 percent range. This makes it a good time to refinance your loan to save money. 

You financed through a dealership

Because dealers work with third parties and mark up their rates, dealer financing usually doesn’t come with the best possible terms. When you finance in-house, the dealer shops your information around to lenders in its network. Some lenders pay higher commissions than others, so the dealer may set you up with a higher-paying lender — even if there’s a better rate offered.  

This isn’t necessarily a bad thing if dealer financing was convenient for you when you bought your car. But if you did, refinancing now at a lower rate could save you. Plus, the dealer won’t be pocketing that extra money that could go toward your other bills. 

Interest rates dropped

Even if you have not improved your credit, lower average interest rates could still benefit you. Since interest rates on car loans change with the prime rate and market conditions, if it’s been a while since you took out your current loan, average car loan rates could be lower.  

According to data from Experian, the average used car rate in 2022 is 8.62 percent. Although refinancing rates will vary, they are usually similar to used car rates. Currently, rates are on the rise though, so it may not be the best time to refinance based on rates alone. 

When to hold off on refinancing 

Even if you can get a lower monthly payment or interest rate, there are situations where it may be sensible to hold off on refinancing. If your current lender charges prepayment penalties for paying your loan off early, refinancing could be costly.    

You should also steer clear of refinancing your car loan if you are nearing the end of your loan term. It is possible to refinance and get a low monthly payment, but you will likely pay more interest. This is because the lender will likely stretch out the remaining balance for an extended period.   

And some lenders may turn you down for financing if your car is older than 10 years or has over 100,000 miles on it. Your application for financing could also be denied if you’re upside-down on your car loan or behind on your loan payments — even if you otherwise have good credit. 

How to refinance your car loan 

You can apply online with most lenders or visit a branch if you want a loan from a bank or credit union. Once you submit your application, the lender will review it and run a credit check to determine whether you qualify for a loan, and what interest rate you will receive.   

This is typically a preapproval process, so you won’t need to submit any documents and can compare rates without committing.  

Once you find and prequalify with a lender to refinance your car loan, reach out before you fully apply to determine what information and documents are needed to process your loan application. Most lenders will request a copy of your driver’s license, a utility bill and proof of income. You will also need to provide proof of insurance along with the make, model, VIN (vehicle identification number) and mileage for your vehicle.   

If you are approved, your new lender will either take care of paying off the old loan or send you the funds to do it yourself. Either way, check with both lenders to ensure all the paperwork and payments have gone through. 

The bottom line 

Refinancing could be a smart financial move if your situation has changed since you took out your current loan. But before you secure a new loan, use an auto refinance calculator to determine if the benefits outweigh the costs. Also, explore potential rates to gauge if you could qualify for a loan with more competitive terms. 

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Written by
Allison Martin
Allison Martin's work began over 10 years ago as a digital content strategist, and she’s since been published in several leading financial outlets, including The Wall Street Journal, MSN Money, MoneyTalksNews, Investopedia, Experian and Credit.com.
Edited by
Auto loans editor