How to Refinance a Car
Car refinancing can be a smart financial move if you want to lower your monthly payments, reduce your interest rate or pay off your car loan faster. However, if you don’t do it correctly you could pay more than you already are. This guide will help you understand how to refinance a car — and the pros and cons of doing so — so you can decide if it’s the right strategy for you.
How car refinancing works
When you refinance a car, you’re essentially replacing your existing auto loan with a new one to get better terms. Usually, this can help you save money, but not always. For example, refinancing may help you lock in a better auto loan rate or adjust the length of your loan to reduce your monthly payment. When you refinance a car, your new lender will pay off your original loan and you’ll start making payments based on the new loan terms.
How to refinance your car in 8 steps
By taking out a new loan to pay off your existing car loan, you may be able to secure better loan terms and improve your financial situation. But to be successful, you’ll have to follow a few best practices and understand the basics of how auto loans work. Here’s a step-by-step overview of how to refinance a car loan to your benefit:
1. Evaluate your existing auto loan
Start by evaluating your existing auto loan and then compare it with refinancing options. Think about how your current loan terms are affecting your financial situation, and check your interest rate, repayment period and fees associated with the loan. Also compare current interest rates to your existing loan. If interest rates are lower, you may qualify for better terms and refinancing may be a smart choice.
However, if interest rates are high, refinancing may actually cause your payments to increase. This is especially true if your credit score has decreased since taking out your original loan. Finally, check if your original loan agreement includes a prepayment fee. If so, the benefits of refinancing may not be worth what you’ll have to pay in penalties.
2. Check your credit score
Credit score is a key factor in determining the terms of your loan, so check your current credit score to evaluate your likelihood of qualifying for a competitive rate. To do so, visit a website like Credit Karma; many credit card companies also offer free credit score updates. To gain more insight into your credit score, request your annual credit report from one of the three main credit bureaus (TransUnion, Equifax or Experian) or go to AnnualCreditReport.com.
If your credit score has improved, you may qualify for a better rate. This is especially true if you’ve achieved a very good (740 to 799) or excellent (above 800) credit score. On the other hand, if your credit score has decreased, you may end up getting a higher interest rate or less attractive terms than you currently have. If this is the case, wait to refinance and take steps to improve your credit score by paying down debts and making on-time payments. This could take several months but may be worthwhile if you want the lowest possible interest rate.
3. Organize documentation for your application
To refinance your car loan, you’ll need to gather the necessary documentation, including proof of income, vehicle registration and insurance. Some lenders require additional documents during the application process, so be sure to check with each company by calling or visiting their website. Preparing everything ahead of time will help you get through the process more quickly and easily.
4. Browse auto refinance loan lenders
Once you have all your documents in order, you can start shopping for a refinance loan that will benefit you. Compare each lender based on available interest rates, repayment terms, fees and additional features. Also visit sites like the Better Business Bureau (BBB) to see how other customers have rated each company you’re considering. These reviews can give you a good indication of the lender’s service and responsiveness.
5. Get pre-qualified and compare your offers
After identifying a few top lenders, start the application process by getting pre-approved for your new car loan. This process varies by lender but usually involves submitting an online form with your personal and financial information. The lender will then review your application and provide you with a pre-qualification offer so you can see the rates and terms you’re likely to qualify for. Note that some websites do this instantly, while others take a few hours.
Compare refinancing offers and carefully consider whether each option works with your financial situation. First, calculate the total cost of the loan, including interest charges and fees. Then, ensure the loan term is reasonable and the monthly payments are affordable. Finally, compare the new loan to your current loan to ensure it will improve your financial situation.
6. Apply with the refinance company that has the best offer
After you select the offer that gives you the best interest rate and terms for your financial situation, submit a formal application. This may involve working with your loan officer and providing additional documentation to complete your application.
Note that some pre-qualified offers could change once you’re in the final steps of the process. Pay close attention to the final offers and make sure you understand the terms of your final offer before committing to a loan.
7. Finalize your loan paperwork
If your application is approved, the lender will provide you with your new loan agreement and any other paperwork that needs to be signed to complete the deal. Review the documents they give you carefully and don't be hesitant to ask questions if you're unsure about anything. Once you're satisfied, sign the paperwork and finalize your refinanced car loan.
8. Pay off your original car loan
After signing the necessary documents, some lenders will deposit the loan funds into your account the same day. However, this is not always the case, and some financial institutions may take a few days to process the funds. Alternatively, many lenders will pay off your current car loan directly rather than disbursing the funds to your account. Finally, start making on-time payments to the new lender based on your refinanced terms.
The benefits of refinancing a car
These are the main benefits of refinancing your car:
Reduced interest rate
One of the main benefits of refinancing is to reduce your interest rate, which means you’ll ultimately pay less over the life of your auto loan. Lowering your interest rate, even by just a few percentage points, can have a significant impact on the amount of interest you pay over time.
For example, if you have a $20,000 car loan with a 6% interest rate and a five-year repayment term, you would pay a total of $23,199.36 in principal and interest over the life of the loan. However, if you refinance your car loan and secure a lower interest rate of 3.5%, you would only pay $21,830.09 in principal and interest. In total, this would save you $1,369.27 over the life of your loan.
Of course, the actual amount of savings will vary depending on your situation. For instance, if you originally had to buy a car with bad credit and your credit score has improved significantly, your interest rate could decrease by several points. If your credit score hasn't really changed, however, you may not be able to achieve a significant difference in interest rates.
Lower monthly payments
Refinancing can lower your monthly payments if you qualify for a more extended repayment term. In this case, your total loan balance will be divided by a greater number of payments, effectively reducing your monthly payment and freeing up cash in your budget.
However, you should be cautious in this situation. Even if you find a loan that lowers your monthly payments, it might not be your best option. If the new loan has a higher interest rate, you could end up paying more than you originally owed. Always consider the new terms when deciding whether to refinance.
If you prefer to repay your car loan quicker, a shorter repayment term will most likely increase your monthly payment. But, by shortening your loan term, you’ll repay your loan sooner and build equity in your car more quickly. You’ll also pay less in interest charges over the life of your loan. Plus, once you pay off your car loan, you’ll own your car outright.
Improved credit score
When you refinance your car loan, your credit score can improve in a number of ways. Lowered monthly payments can make it easier to make on-time payments on your new car loan. On-time payments help you build a positive credit history and can boost your credit score over time. Lowered monthly payments also decrease your debt-to-income ratio, which is your monthly debt payments compared to your income. Lenders look at this metric when evaluating your creditworthiness.
If you’re able to secure the lowest auto refinance rates, you may be able to pay off your loan more quickly. This can also improve your credit score because you’ll reduce your debt.
The drawbacks of refinancing a car
Refinancing your car can be beneficial, but it’s not the right choice for everyone. These are the main disadvantages of refinancing a car:
Additional fees
Depending on your situation, refinancing your car loan may come with additional fees. Refinancing fees vary, but they can range from a few hundred to several thousands of dollars. These fees can include application fees, origination fees and prepayment penalties.
Refinancing fees can add up quickly and may negate any savings you might gain from a lower interest rate or shorter loan term. Many of these fees are hidden until the last steps of your application, so consider these costs when deciding if refinancing makes financial sense for you.
Higher interest costs
While the primary goal of refinancing is often to lower your interest rate, extending the term of your loan can ultimately result in paying more in interest. Moreover, some refinancing loans may come with a variable interest rate that can change over time.
For example, if you have five years left on your current car loan and the repayment term of your refinance loan is seven years, you will be paying interest for an additional two years. Even if you secure a lower interest rate, interest will accrue over a longer period and you may pay more over the life of the loan.
Cycle of debt
In some cases, refinancing can also bring you further into debt. Extending your loan term or taking cash out of your equity are two common ways that refinancing can increase your debt. If you aren’t careful when refinancing, you could owe more than the value of your car. If you take cash out of your equity, you’ll borrow more than the car is worth. This can increase your debt by leaving you with a loan balance that exceeds the car’s value.
If you find yourself upside-down on your loan, it may be difficult to sell your car. In that case, you’ll need to pay off the outstanding loan balance, and if you owe more than the car’s value, you’ll need to make up the difference. Depending on your loans, this could amount to thousands of dollars.
Summary of Money’s how to refinance a car
Refinancing your car can be a great way to lower your monthly payments or pay off your loan in a shorter amount of time. However, if you aren’t careful during the refinancing process, you could end up increasing the total amount that you owe.
To effectively refinance your car, evaluate your existing auto loan, look over your credit report, gather the necessary documentation and compare the best auto refinance companies. Then, apply for pre-qualified offers, read everything carefully and select the offer that best fits your needs.
If you’re trying to refinance your car to pay off the loan and purchase another vehicle, consider a car subscription. This is an alternative option for obtaining a new car that might be suited for your situation.