These days, taking out an auto loan is an expected part of buying a car for many Americans, enabling them to purchase a vehicle without needing tens of thousands of dollars all at once. According to the credit reporting agency Experian, more than 85% of new cars on the road in 2019 were financed.
But with repayment terms that are typically many years in length, car owners may find themselves considering the value of refinancing their auto loan, long before the car is paid off. An auto loan refinance can make it easier to pay off your vehicle faster, and also result in savings both monthly and over the long term.
Let’s look at the factors that go into refinancing an auto loan, why you might consider this strategy, and where to start when handling your own auto loan.
What refinancing an auto loan means
At its simplest, auto loan refinancing is a way of replacing an existing auto loan with a new loan that ideally has more favorable terms. Refinancing an auto loan is a great way for borrowers to reduce auto monthly auto loan payments, get a lower interest rate, shorten the loan’s repayment period, remove a cosigner from the agreement, or all of these at once.
As with all loans, the more creditworthy you are, the better the terms of your auto loan refinance may be. A refi may be offered to you by your current lender or a new lender entirely. After you refinance your car, you will have an entirely new loan with its own terms, monthly payment, and due date.
The value of refinancing your auto loan
Some borrowers choose to refinance simply to release a co-borrower or to adjust their monthly car payment amount. However, one of the biggest benefits of a refi is the potential APR savings. APR stands for annual percentage rate and, simply put, it is the amount of interest you pay on your loan.
By lowering your interest rate, you can pay off your auto loan for less total cost even if you continue to make the same monthly payments. In many cases, this also gets you out of debt sooner than if you stuck with your original loan terms. Let’s look at an example.
Say you buy a $25,000 car, financed with a six-year auto loan at a 6.5% APR. The monthly payment on that loan is $420. If you make all 72 payments as scheduled, you will pay a total of $30,258 for your new car, $5,258 of which is strictly interest that is paid to your lender.
Now, let’s say that after a year, you decide to refinance your remaining auto loan amount instead. You have already made 12 payments and paid $1,538 in interest. Your remaining loan balance is $21,478. If you stayed with your original loan, that balance would be paid out over 60 more months and would include another $3,737 in finance charges.
But instead you opt for a 60-month refinance loan (so your car will still be paid off at the exact same time), and you qualify for a reduced interest rate of 3% APR. Because of this, you get to enjoy a lower monthly payment of $386. Over the course of the next 60 months with your new refi loan, you pay out a total of $23,156. Of that, only $1,678 is interest.
In this payment example, if you chose to refinance your auto loan instead of continuing to pay on your existing auto loan as scheduled, you’d save a notable chunk of change. The lower-interest refinance loan will save you $2,059 over the course of your payoff.
|Original loan, final 60 months||Refinanced loan, 60 months|
|Remaining loan balance||$21,478||$21,478|
|Remaining payments||60 months||60 months|
|Interest rate||6.5% APR||3.0% APR|
When refinancing your auto loan can be a good idea
There are certain times when it makes the most sense to do an auto loan refinance, depending on your personal situation and reasons for refinancing. Here are some of the biggest reasons you may want to start shopping for a new car loan.
Your credit score has improved
As long as you are responsibly managing your finances, you can expect your credit score to steadily improve over time. When it does, you might find you are able to qualify for more competitive loan terms than when you originally bought your car,
If your credit score has increased since taking out the auto loan and/or negative items have fallen off of your credit report, you could benefit from a refi, especially if doing so results in a lower interest rate.
Your LTV is low enough
Auto loans are often thought of in terms of LTV, or the loan-to-value ratio. This calculation takes into account the actual value of a financed vehicle at any given point compared with how much is still owed on it. Until the vehicle’s LTV hits a certain mark, you’ll have trouble refinancing the loan. That’s because there isn’t enough equity in the vehicle to make the loan enticing enough for lenders. This is also part of why it can be hard to get the lowest rates when trying to finance a used car.
Once you hit an LTV of around 85%, though, lenders will usually begin considering your refi loan request. You may then be able to qualify for a new loan and save money on your vehicle over the life of the loan. Just note that each lender has their own LTV threshold, and it may even vary based on your credit history and income.
Interest rates have dropped
The interest rates offered on your auto loan can be impacted by many factors, such as your credit score, loan terms, and even the cost of your vehicle. However, economic factors can also play a role. Federal interest rate changes can have a particular impact.
If the market has changed and federal interest rates have dropped significantly since you bought your car, it might be worth looking into a refinance. This can be a simple way to lower your APR even if your credit hasn’t changed much.
You can get (or want) a lower monthly payment
When you finance a car, you agree to make specific monthly payments for a set period of time. At some point, though, you may find yourself struggling to manage those payments, or your monthly budget might need a little bit of wiggle room. Failing to make full payments isn’t an option or you risk defaulting on your loan. What can you do?
Refinancing could be a good option at this point. With a refi, you can choose a longer term that spreads out your remaining balance and lowers your monthly payment amount. If your finances loosen back up and you can afford to make larger payments, great. But refinancing gives you the flexibility and helps you lower your monthly payment if and when you need it.
Just note that even if getting a lower payment meets your shorter-term financial goals, it also has the potential to cost you more in interest over the life of your loan. If your interest rate isn’t also reduced at the same time — and you’re simply spreading your remaining balance out over a longer period — you will pay more in finance charges by the time your car is paid off.
It’s time to release your co-borrower
There are many reasons to have added a cosigner to an auto loan, whether you were unable to qualify for a loan on your own or if you bought the vehicle jointly with someone else. Over time, though, you may find you want (or need) to release that co-borrower from the debt. To do so, you’ll typically need to be able to qualify for the new loan with your own credit and income, and your lender will need to allow for co-borrower release.
Not all auto loan lenders offer this option, so in these cases, refinancing may be the only way to remove your co-borrower from your auto loan. Refinancing enables you to take on the total debt by yourself if you are financially stable and have improved your credit enough to do so. This releases the co-borrower — whether a parent, close friend, or significant other — from the loan and removes their legal obligation to the debt.
You can also use a refinance loan if you bought the vehicle jointly with someone else, such as an ex-spouse. If you’re dealing with debt and divorce, then refinancing could allow you to put the car in your own name if your lender won’t simply release the other person from the loan.
Important factors to consider when refinancing an auto loan
There are a few things you’ll want to keep in mind if you’re thinking about refinancing your auto loan. Understanding these factors can help you time your refinance to find low rates and avoid unnecessary hassle.
There may be penalties and fees involved
In some cases, you may find that your lender charges a prepayment penalty. If this penalty is included in your loan terms, then refinancing — and satisfying your original debt ahead of schedule — can cost you more than planned. It’s important to read the fine print of your contract to see whether a prepayment penalty exists and, if so, how much it will be.
Similarly, your new lender may charge you an origination fee as part of refinancing your loan. These fees don’t mean a refinance is automatically a bad idea, but it’s important that you consider them and do some math. Make sure that refinancing and paying a fee will still result in savings in the end.
Your car may be too old
Most lenders will have vehicle requirements your situation must meet in order for them to offer you a refinance loan. One of these requirements typically involves the car’s age, which has an impact on both the current value of the vehicle and its projected longevity.
The older the model year of your car, the more of a risk it poses to your lender when it comes to their money. As a result, you might not qualify for a refinance loan if your vehicle is too old. Although each lender has its own rules, you can expect this vehicle age threshold to be around the 10-year mark.
You might have too many miles
If your car has been driven too much — regardless of its age — you might not be eligible for a refi. Some lenders set a limit of around 125,000 miles. If your car has more than that, you probably can’t refinance.
Cars today are built to stay on the road for a long time, and exceeding 125,000 on the odometer isn’t necessarily that rare. As your car gets older, though, it loses value. And because refinance lenders work to mitigate their risk based on the value of your car, you’ll often find that they are unwilling to refinance a loan on a vehicle that has racked up too many miles.
You haven’t owned your car for long enough
As long as you meet the vehicle and personal requirements, there technically isn’t a limit to the number of times you can refinance your auto loan. However, you’ll generally find you can’t refinance unless you’ve been paying on your current loan for a certain amount of time.
If you’re interested in a certain lender, find out whether it has a requirement for how many months you need to have paid on your current loan before they’ll consider you for a refinance. If you’re a first-time car owner, you might want to wait a year or so, to establish a healthy payment history and better prove your creditworthiness before requesting a new loan.
How to find the right lender for your new auto loan
If you think you’re ready to refinance your current auto loan into a new loan, it’s time to find the right lender. Here are a couple of tips to help you successfully shop for a new auto loan:
- Start close to home. The best lender for you might be just around the corner. Start by shopping around with your current bank or credit union, or applying through a different local financial institution. You might find more competitive rates and a more personalized experience, especially if you already have a relationship with the bank. Its agents may prove to be an informative resource if you’re not even sure how to get a loan in the first place.
- Shop around through aggregators. There are many excellent online platforms these days, helping connect borrowers to the right lenders. These platforms, called aggregators, allow you to shop around for the best rates and loan terms through multiple lenders at once, saving both time and energy, as you have only to enter your information one time.
Is refinancing your auto loan worth it?
Refinancing an auto loan is often a beneficial move that can save you hundreds or even thousands of dollars over the course of your auto loan repayment. It’s a worthwhile process if refinancing your car loan will result in a notably lower interest rate, a monthly payment that better fits your budget, or the removal of a cosigner you no longer need on the loan.
What credit score do I need to refinance my car?
As with all loan products, there are refinance lenders willing to at least consider applicants whether you have bad or good credit. The better your credit, however, the better your chances of getting approved for more desirable refinance rates and repayment terms that can save you the most money. In order to qualify for the best rates, expect to need a credit score of 700 or higher. Many refi lenders will require credit scores of 600-plus to be eligible for a new loan.
Where is the best place to refinance a car loan?
Start your search for a refinance auto loan lender by looking nearby, such as small local banks and credit unions. If you have a relationship with a particular bank, reach out to your representative there and see about your options. Online comparison platforms are also a great place to look for auto loan rates, helping connect you to multiple lenders and offers at one time.
Auto loans are an integral part of car-buying for many people, providing the financing needed to buy a used or new vehicle. Refinancing auto loans down the line, however, can help borrowers save more money over time by allowing them to get even better rates or a new window for repayment with more suitable terms.