If you don’t know how to refinance a car loan, you could be leaving money on the table. In fact, a report by RateGenius shows the average annual savings on refinanced car loans in 2020 was $989.72. Even better, the same report shows over 42% of Americans with successful auto loan refinance applications saved more than $1,000 per year on their loan.
But if you want to get in on these savings, you’ll need to know how the refinancing process works. In this guide, we’ll take you through the necessary steps for refinancing a car loan and also explain when it is (and isn’t) a good idea. This will help you learn how to refinance a car loan and decide whether it could be the right move for your personal finance situation.
What does refinancing a car loan mean?
Refinancing an auto loan means replacing your current auto loan with a new one. In effect, a new lender pays off your original loan and sets you up with a new loan. This would typically be done to get more favorable loan terms.
For example, you might want to lower your APR (annual percentage rate), which is your interest rate plus any associated fees, so you can save money on interest payments over the life of the loan. Or it could make sense to increase the length of your loan so your monthly payments go down and become more affordable.
How to know if refinancing a car loan is right for you
Whether you want to save money or reduce your monthly car payment, it’s important to consider multiple factors associated with refinancing a car loan. In some cases, it might make sense to do a refinance, but it might not in others.
When is refinancing a car loan a good idea?
Switching from an old loan to a new auto loan might be a good idea in these situations:
- Loan rates are down: Interest rates, including car loan APRs, typically follow trends depending on the economy. If average rates are going down, you likely have more opportunities to secure a lower interest rate when refinancing a car loan.
- Your credit score has improved: Your credit history plays a big role when it comes to the terms you’ll get offered for a new car loan. If your credit score has improved since you first took out a car loan, you could refinance and qualify for a better interest rate and save money. Or you may be able to switch to a preferable financial institution.
- You can pay off your loan quicker: If you can qualify for a refinance with a shorter term length, which is the length of time you have to pay off the loan, you might be able to pay your loan off quicker and save on interest. For example, if you have a 60-month car loan and qualify for a 36-month car loan refinance at the same or lower interest rate, you could avoid paying interest on 24 months of payments and save money.
- You’re having trouble with loan payments: If you can’t keep up with your current payments, it could make sense to refinance your car loan and increase its term length. This typically reduces the cost of your monthly payments since they get spread out over a longer period of time. However, you might pay more interest over the course of the loan.
When is refinancing a car loan a bad idea?
Refinancing a car loan might be a bad idea in these situations:
- Loan rates are up: If interest rates have increased on average since you first took out your car loan, it’s likely not the best time to refinance. You likely don’t want to end up with a higher interest rate than you already have unless you need to increase your loan’s term length to better afford monthly payments.
- Your credit score has gone down: If your credit score has gone down from when you originally took out your car loan, refinancing won’t often offer a better deal on interest rates.
- You’re upside down on the loan: Being upside down on a car loan means owing more money than the car is currently worth. Refinancing in this case wouldn’t make sense if you can’t get a lower interest rate or shorter term length. Also, some lenders won’t offer you auto loan refinancing unless you first pay the difference between the remaining balance on your existing loan and your vehicle’s current value.
- Prepayment penalties are high: Some car loans have fees, called prepayment penalties, if you pay off your owed amount early. This is to help the lender make back some of the money it’s losing from lost interest payments. If your current car loan has high prepayment penalties, it might not make sense to consider a refinance.
How to refinance a car loan (in 6 simple steps)
To get started with refinancing a car loan, follow these steps:
1. Check your credit score
Your credit score is often the biggest factor in determining what kind of car loans are available to you. If you have a good credit score, you’ll typically qualify for loans with more competitive rates and term lengths. The same applies to refinancing a car loan.
Knowing your credit score can give you a better idea of what to expect if you’re considering a refinance. This is especially important if you think your credit score has changed from when you first started your existing car loan. If your credit score has gone down, it might not make sense to refinance. But if you’ve improved your score, you could qualify for better terms.
You can get started by checking your FICO Score, a type of credit score, for free with Experian.
2. Organize your loan information
You’ll need to provide certain information about your existing car loan when applying for a refinance. This may include:
- Remaining loan amount: The amount you still owe on your existing loan.
- Monthly payment amount: How much you pay each month on your loan.
- Interest rate: The amount of interest you have to pay on your loan.
- Current lender: The name of the lender your current loan is under.
You can get this information from your most recent paper loan statement or in your online account. If you can’t find certain information, be sure to contact your lender. Then you can write down the information and have it ready when you need it.
3. Organize your personal information
In addition to loan information, you typically need personal information on hand when applying to refinance a car loan. This would be similar to car-buying documents and may include:
- Income: Proof of income or employment may include recent pay stubs, tax returns, or bank statements.
- Identification: Your driver’s license and Social Security number are often required for identification purposes.
- Insurance: You will likely be asked to provide proof of insurance. Your insurance policy documents should list the coverages you have, what vehicle is insured, the policyholder, and other applicable information. If you don’t have these documents, you can request them from your insurance company.
- Residence: Utility bills — like water, gas, or electricity bills — are commonly accepted as proof of residence. A recent mortgage statement or lease agreement could also work.
- Vehicle information: Have your vehicle information handy, including its vehicle identification number (VIN) and year, make, and model. You can typically find this information on the vehicle’s title, registration, and insurance documents.
4. Apply for your new car loan
Many banks and credit unions offer car loan refinancing, and you can typically apply directly through each company’s website. But if you want to get a feel for all the loan terms that might be available, consider using an online marketplace that lets you check multiple rate estimates from different lenders without affecting your credit score.
Most direct lenders will initiate a hard credit pull when you check auto loan rates with them since you’re essentially applying for the loan. This can lower your credit score slightly, but won’t have a permanent impact. But certain online marketplaces will only do a soft credit check, which won’t impact your credit score. You can use these websites to get rate estimates before committing to a specific car loan refinance.
If you do end up filling out multiple applications that require a hard credit inquiry, be sure to group those loan applications together so you don’t take a big hit on your credit score. Credit scoring models typically count multiple loan applications that have occurred within a short period of time, from 14 to 45 days depending on the scoring model, as one hard inquiry instead of various.
5. Evaluate your loan offers
Every loan offer you receive will be different, so it’s important to look for certain factors when comparing them. The offer with the lowest interest rate or longest term length won’t always be the best option, as it depends on your personal financial situation as well as any additional costs.
Here are a few factors to consider when evaluating your loan offers:
- Interest rate: The lower the interest rate, the less interest you pay on your monthly payments. One way to save money is to secure a rate lower than your current interest rate.
- Term length: A shorter term means you’ll pay off the loan quicker, but it likely means higher monthly payments as well. A longer term means taking longer to pay off the loan and likely paying more interest over the life of your loan. But it could make sense if you need lower monthly payments.
- Fees: Keep an eye out for prepayment penalty fees, loan processing fees, titling fees, re-registration fees, and other fees.
These factors should be considered as a whole instead of on their own. For example, a loan with a low interest rate but loads of fees may not be as helpful as a loan with a slightly higher interest rate and low fees.
6. Finalize your refinanced auto loan
To finalize your loan, choose the offer you want to go with and sign the loan agreement. If you hadn’t already received a hard inquiry on your credit, you’ll receive one now. You also might see a slight change in the loan offer terms after the hard inquiry. This is because the lender now has a better understanding of your creditworthiness and has adjusted their offer. Make sure you re-read all the loan paperwork before you sign. You’ll also likely have to provide all the documents and information you gathered earlier at this step.
Is refinancing your auto loan worth it?
Refinancing your auto loan is worth it if it makes sense for your financial situation. If refinancing could help you save money on interest, make your monthly payments more affordable, or help you pay off the loan quicker, it might be worth it.
Does refinancing a car hurt your credit?
Applying for most loans, including an auto refinancing loan, typically hits your credit with a hard inquiry. A hard inquiry could stay on your credit report for up to two years and could slightly lower your credit score, but it won’t likely have any significant impact on your credit after a few months. It’s a smart strategy to group multiple loan applications close together since credit scoring models will consider multiple inquiries around the same time as only one hard inquiry on your credit report.
Do I need a down payment to refinance my car?
You don’t typically need a down payment to refinance your car with a new loan. But if you owe more on your existing loan than what the vehicle is worth, which is called being upside down on the loan, certain lenders may require you to pay the difference before you can qualify for refinancing. You also might have to pay certain fees, like loan application fees or fees to transfer the vehicle title and registration.
Knowing how to get a loan is an important resource for keeping your financial opportunities open. It makes it easier to plan out your finances and can possibly save you money at the same time. Refinancing a car loan isn’t much different from taking out a car loan when you first buy a vehicle from the dealership. You need certain documents on hand and having multiple options for loans can help you narrow down your choices.
But remember, the best car loan refinance for someone else might not be the best for you. Consider your situation when evaluating your loan offers to decide which refinance offers most align with your financial goals and repayment needs.