After taking out a loan to purchase a vehicle, you might consider refinancing to help you pay off that debt. If you refinance your car loan, you can get a better interest rate or change your repayment terms—which could save you money.
It’s important not to rush into the process, however. It will ultimately benefit you to do your due diligence and take the time to learn how refinancing works first.
Can You Refinance a Car Loan?
The short answer is yes—you can refinance your car loan. If interest rates have dropped since you took out your car loan or you now have a better credit score, then you can refinance to a lower rate. This will not only lower your monthly car payment but also reduce the amount you pay in interest over the life of the loan.
How Does Refinancing a Car Work?
When you refinance your car loan, you’ll take out a new loan with different terms that replaces your original loan. Then you’ll begin making monthly payments on the new loan.
You can choose to refinance with your existing lender or pick a new lender after shopping around to compare fees, rates and special offers.
The lender you choose will appraise your vehicle, run a credit check, verify your income and ask for proof of car insurance. You may need to provide recent pay stubs or W-2s for the last two years to assure the lender that you can make the monthly payments.
4 Things to Know Before Refinancing
Refinancing can make owning a car more budget-friendly, but it could also mean you end up paying more in the long run. So before you decide to refinance, you should know these four important things:
1. How to Shop Around and Compare Lenders
In addition to your current lender, you should compare the offerings of auto finance companies, online lenders, traditional banks and credit unions. This will ensure you get the best rate possible.
Keep in mind that applying for an auto loan refinance counts as a hard inquiry on your credit report, which could cause your credit score to drop by a few points. If you submit all the applications within a certain period of time, however, they’ll count as a single inquiry.
The time frame is typically between 14 and 45 days. This limits the negative impact on your credit score and allows you to explore as many options as you want.
2. What Fees You Might Have to Pay
Some lenders include a prepayment penalty in the car loan agreement for paying off the debt early. Be sure to check if your current loan has prepayment penalties, as it could negate any savings you get through refinancing.
Read more: What Does It Mean to Refinance a Loan?
Depending on the lender, you might also have to pay an application fee, registration fee and/or title transfer fee. When refinancing, some states will also require you to pay to re-register your vehicle—but the cost of these fees depends on where you live.
3. Your Car’s Value
Before you reach out to any lenders, do your research to find out how much your current car is worth. This is usually determined by its make, model, year and mileage. Check the National Automobile Dealers Association’s (NADA) Guides or commercial websites such as Consumer Reports, Edmunds and Kelley Blue Book (KBB).
Once you know how much your current vehicle is worth, you can decide whether you should refinance your loan—or if it makes more sense to trade or sell it. The lender will also assess the car’s value before approving your refinancing application. If the value is too low, you won’t qualify.
4. Refinancing Requirements
Each lender has specific refinancing requirements, so ask as many questions as possible while shopping around and get all the information you can before you apply. Most lenders’ key requirements include:
How Much You Owe and Your Car’s History
Your ability to refinance will likely depend on how much you still owe on your car loan, the age of the vehicle and the vehicle’s mileage. Some lenders won’t refinance older or high-mileage vehicles, and most will refuse to refinance a loan on a car with a salvage title.
You should know your car’s loan-to-value (LTV) ratio before you apply to refinance, as the lender will also use this to decide your eligibility and loan terms.
This is because your vehicle is collateral for the loan, and its actual value is often lower than what you paid for it. The lender may require a down payment from you to trim the size of the loan so that how much you owe isn’t more than the vehicle is worth.
Tip: To calculate your LTV, divide the current loan balance by the car’s value; the resulting percentage is the LTV.
Your credit report and credit score play a key role in determining if you’re able to refinance and what your borrowing costs will be. A higher credit score makes you a less risky borrower and can help you secure a lower interest rate.
Should You Refinance Your Car Loan?
Whether or not you should refinance your car loan comes down to your unique situation and what it would mean for your budget in the near- and long-term. But here are a few scenarios where it would make sense to refinance—and some that wouldn’t.
When It Makes Sense to Refinance
- Your credit has improved. You might be eligible for a better rate if your credit score has improved significantly since you initially took out the loan. If your credit score is still less than stellar, however, you can refinance using a co-signer with a strong credit history to potentially receive a better rate.
- You want a lower monthly payment. If you’re struggling to keep up with debt payments, and need some extra room in your budget, refinancing to get a lower payment can be a good option. Just keep in mind that if you choose a longer term to get that lower payment, it will cause you to pay more in interest over the length of the loan.
- Interest rates are lower. Another reason to refinance would be if you have a high interest rate on your current car loan and interest rates are now lower.
When It Doesn’t Make Sense to Refinance
- You’re upside down on your current loan. You shouldn’t refinance your car loan if you owe more on your current vehicle than it’s worth—also known as being upside down, which means you have negative equity.
- You’ll be hit with a prepayment penalty. Another reason not to do it is if your current lender has a prepayment penalty in place that costs more than any potential savings.
- You’re currently applying for another loan. If you’re applying for another loan, like a mortgage, refinancing your car loan at the same time isn’t ideal. Your credit score would be negatively impacted, making it hard for you to get the loan, or you could be saddled with a higher interest rate.
- You have a low balance on your current loan. If you have a low outstanding balance on your existing car loan, it doesn’t make sense to refinance. Instead, you should either pay it all off to free up room in your budget or keep making payments to make your credit record as strong as possible.
It’s important to remember that the longer you take to repay your loan, the more interest you’ll have to pay over time. So be sure to use an auto loan calculator to see if refinancing will save you money before making your final decision.
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