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Auto Loan Refinance 101
Basic Definition of Auto Loan Refinancing
Essentially, auto loan refinancing is taking out a new loan to pay off your existing car loan. Depending on individual financial situations, applicants could qualify for a lower interest rate through refinancing—which could mean lower monthly payments and saving money in the long run.
How Auto Loan Refinancing Works
The goal of auto loan refinancing is to secure a new loan with better rates or terms than your previous loan. Here’s an example of what refinancing an auto loan may look like:
Sam took out a car loan in late 2019. At the time, Sam had a low income and credit score, plus a fair amount of debt. This financial situation resulted in an interest rate of 16.88% for a subprime borrower on a used car—higher than the national average of 9.49% for used cars.
Since purchasing the car, Sam's income has risen, his debt has shrunk, and his credit score has improved. As a result, Sam thinks a lender would offer a lower interest rate today.
So Sam decides to investigate car loan refinancing by:
Setting goals for the new loan.
Researching online and brick-and-mortar lenders, including his current lender (some lenders allow internal refinancing), and choosing a few possibilities.
Self-reporting information to preferred lenders to see what prequalifying rates look like (if available).
Reading the fine print for preferred potential lenders to make sure all terms are clear.
Applying for the refinancing loan.
Sam may not find a better rate or terms. But given Sam's income, debt-to-income ratio (DTI), and credit score improvements, a lender may make a reasonable auto refinancing offer.
If Sam does find a significantly better option, that's when step 5 happens. Remember: a prequalified offer may not be identical to the final one because the prequalification doesn't include a hard credit check.
When the car loan refinancing paperwork is signed, the new loan is used to pay off the original loan, and now Sam makes regular payments to the new lender.
When to Think About Refinancing an Auto Loan
You might consider refinancing your auto loan in several circumstances, including when:
Your income, credit, and/or debt-to-income ratio have greatly improved. In other words, you present less risk as a borrower compared to when you first took out the auto loan.
Interest rates have dropped in general.
You realize your current lender charged you a higher interest rate than you could have qualified for (e.g. if you originally financed through a dealership).
You want to remove a cosigner but can't or don't want to do so via a standard release.
You may also consider refinancing your car loan when you can't keep up with payments for your current loan, but you should first consider other options. Lower monthly payments are usually achieved as the result of a longer-term loan, which in turn can mean paying more over the life of the loan, even if the new interest rate is lower — and while the car is depreciating in value.
Info You’ll Need to Apply for an Auto Loan Refinance
When an individual applies to refinance with a new lender, there is typically a credit check of some kind. Each lender reviews specific borrower criteria, which varies from lender to lender, and influences the rate and terms an applicant may qualify for. For an auto loan refinance application, lenders typically require information that tells them the value of the car, the amount of the current loan and the applicant’s financial picture.
Tips for When You’re Shopping Rates
Pay close attention to loan terms, which can vary greatly, depending on the lender. The longer the loan term, the lower the monthly payments will be, but that means more interest will be paid over the life of the loan. Conversely, a shorter loan term may mean higher monthly payments, but then less is paid in interest over the life of the loan.
Refinancing a Car Loan With Bad Credit
Refinancing an auto loan with bad credit may be difficult, but it may not be impossible. Lenders typically handle vehicle refinancing on a case-by-case basis.
You may be able to refinance with bad credit if you have a positive track record of making payments on your current loan and/or have a cosigner. Shop around before deciding if refinancing is right for you, and don't let any lender run a hard credit check until you've determined that refinancing your car loan with the lender is right for you.
If you're considering refinancing and are coming up empty-handed, talk to your current lender. They may be open to discussing options.
Pros and Cons of Refinancing a Car Loan
There are benefits and drawbacks to refinancing an auto loan, no matter your situation. You should weigh these carefully when deciding whether refinancing is right for you. Remember, none of the pros or cons of refinancing car loans are guarantees. Every situation and every lender is different.
Pros of Refinancing an Auto Loan
Potential benefits of refinancing an auto loan include:
Lower interest rates: If your financial and credit situations have significantly improved since you took out the original loan, you could qualify for a lower interest rate.
Budget-friendly monthly payments: Refinancing your loan may result in lower payments each month if you decide to extend your loan term.
Cash for other expenses: If you have positive equity (i.e. your car is worth more than your current loan amount), you may be able to refinance your auto loan using your car as collateral. This means you can take out more than what you currently owe on your car and use that additional money for other expenses.
Cons of Refinancing an Auto Loan
Potential downsides of refinancing an auto loan include:
Lowering your credit score: A lender will pull a hard credit check before making an official refinancing offer, and the hard credit check affects your credit score whether or not you choose to refinance.
Paying more in the long run: While monthly payments may be more budget-friendly in the short term, they may entail a longer loan term. As a result, lower monthly payments can result in paying more in interest over the life of the loan.
Risking your vehicle: If you used your car as collateral for a personal loan, as described above, falling behind or stopping payments could result in the lender repossessing your vehicle.
Reasons Refinancing Could Be a Good Idea
If your financial situation has improved since taking out your auto loan, you could qualify for a better rate. Improving a credit score, landing a better job, or paying off some other debts may cause a lender to consider an applicant as less of a risk than when they financed a car originally. Qualifying for a more favorable rate now could mean saving money over the life of the loan.