Staring down a hefty car payment every month can be intimidating. If you’ve run into a financial emergency or just want to save a little cash every month to put toward other expenses, you may be considering refinancing your auto loan.
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 result in monthly and long-term savings.
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 auto loan.
How does refinancing a car work?
In the simplest terms, refinancing an auto loan means replacing the terms of your current auto loan with new terms, ideally at a lower interest rate.
Think of it like refinancing a home loan; a refinance uses one loan to pay off a new one. Most of the time, a refinance is done with a new lender.
Typically, borrowers refinance to take advantage of a lower interest rate. A lower interest rate may be available due to market changes or changes in your personal finances, like if you have paid off a lot of debt or increased your income. Other common reasons to refinance include removing a borrower (or cosigner) from the loan or adjusting the length of your current loan.
One of the most important things to understand is that refinancing an auto loan may not lower your monthly payments. In fact, your monthly payment could go up substantially.
Whether your loan goes up or down depends on what terms you change. For example, switching to a shorter repayment period could increase your monthly payments as you’ll have fewer months to repay the total loan, while decreasing your interest rates or extending the length of your loan will likely reduce the total monthly payment.
When should I refinance my car?
It would be best to wait at least six months to refinance your auto loan. There are a few reasons for this, but primarily, waiting to refinance looks better on your credit score and makes it easier to get a good deal.
If you’re paying off debt or increasing your income, waiting at least six months provides ample time for your credit reports to update and build a history of on-time payments.
It's important to calculate your car's loan-to-value (LTV) ratio before applying to refinance to ensure you're eligible to refinance and to get the best terms. Lenders typically won’t approve you or will charge much higher interest rates if you owe more on the car than it is worth — this is called being "upside-down" on your loan.
TipTo calculate your LTV, divide the loan amount by the car's value and multiply the result by 100 to get a percentage. For example, if you borrowed $22,000 to buy a $25,000 car, your LTV would be ($22,000/$25,000) x 100, or 88%.
You also might want to wait to refinance if you've recently taken out any other loans. Personal loans, mortgages, and credit cards will all cause a temporary dip in your credit score since they require a hard credit inquiry. Waiting for your score to recover can help you get better refinancing rates for your car.
Is it bad to refinance an auto loan?
Refinancing any loan is not inherently bad or good. This is one instance where individual circumstances do make a huge difference.
For example, an individual with a fair credit score prepping to buy a home in the next few months might hold off to avoid any hard inquiries and potential dings to their credit score. But, someone with the same credit score who is struggling to pay their bills might consider a refinance to free up a little extra money in their budget.
Is refinancing a car loan worth it?
Again, the answer here depends on whether or not the benefits outweigh the risks for your financial situation. Can you afford to have additional credit inquiries? Does switching lenders bother you? Have you used an auto refinance calculator to figure out how much more or less you could be spending each month?
Auto loan refinancing 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 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 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 same time), and you qualify for a reduced interest rate of 3% APR. Because of this, you can enjoy a lower monthly payment of $386. So over 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 example, if you chose to refinance your auto loan instead of continuing to pay on your existing loan as scheduled, you’d save a notable chunk of change. The lower-interest refinance loan will save you $2,059 over the life of your loan.
|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|
Pros and cons of refinancing
Refinancing a car isn’t a decision to take lightly. Even applying for a refinance could affect your credit score, potentially making it more difficult to get lower rates or approval for other loans. Here are some pros and cons to consider.
- A lower interest rate. Lower rates could make it easier for you to pay off your car faster and save money on interest payments over the life of the loan.
- Lower payments. A better interest rate and longer terms for your loan could mean more cash in your wallet every month.
- Add extra money to your wallet. If you owe less than your car is worth, you could refinance for a larger amount (that’s still less than the car is worth) and use the leftover cash to pay off another bill.
- Paying more interest. If you extend your loan, you could end up paying more interest since you’re paying for a longer amount of time. You’ll need to use an auto loan calculator or talk to your lender to determine if your current needs outweigh this potential extra expense.
- Switching lenders. In most cases, a refinance means you’ll be working with a different lender. If you like your current lender, it may be worth calling them to see if they can work with you on the interest rate rather than going through a refinance with another company.
- You might not qualify. Some lenders have an age limit on the vehicle, or your credit score may be too low. If you apply and allow the lender to check your credit history, you could unnecessarily ding your score. Consider checking your credit report(s) before applying.
- You may face prepayment penalties. Your current lender may have a prepayment penalty clause in your auto loan policy. If your lender does include this clause, crunch the numbers to figure out if the penalty could cost your more than the refinance is worth.
Who should I refinance my car with?
If you have decided to move forward with refinancing your auto loan, finding the right lender is the best way to make sure you get the best terms possible.
- 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 for the best rates and loan terms through multiple lenders at once, saving time and energy, as you only have to enter your information once.
Questions to ask a refinancing lender
When researching potential lenders, make sure to ask the following questions. You may also be able to find answers on the lender’s website since many of them are transparent about loan terms.
- Do you have any added fees (like loan origination fees)?
- Does your loan have an early payment penalty?
- How long will the refinancing process take?
- Do I need to continue making regular auto payments until the refinance goes through?
- Is my interest rate fixed? (If you get into an adjustable rate, your rates could go up or down over the life of the loan)
- What is the monthly payment?
- What is the APR for the refinanced loan?
- Do you offer any other benefits?
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.
If you plan to refinance, doing so earlier rather than later could save you more money, especially if you qualify for a lower interest rate. But don’t blindly leap into a refinance without looking at your budget, asking potential lenders the tough questions, and deciding if the benefits outweigh the risks for your situation.