How to refinance your car loan

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Not everyone qualifies for competitive rates when they first take out a car loan. Dealers tend to mark up their interest rates, and if your credit was less than perfect, you may not have been able to score other financing.

Refinancing your car loan is an option that can lower your interest rate. When refinancing, your current loan is replaced with a new one that ideally includes a more competitive interest rate. The new rate can help lower your monthly payments and the costs you’ll pay over the life of the loan. But to make the most out of refinancing, you will need good credit and a history of on-time payments.

7 steps to refinance your auto loan

There are a few extra steps when you want to refinance a car loan. But generally, it’s about the same process as applying for any other car loan. Review your current finances and loan documents, then find the right lender to meet your needs.

1. Decide if refinancing is the right financial move

There are two main reasons to refinance: if you can get a better rate or if you are struggling to make payments.

The first scenario is common if you took out your auto loan when interest rates were high or when you had a low credit score. If your credit score has improved since you got your loan, lenders will likely offer you better terms, which will help you save money over the life of the loan.

On the other hand, if you feel like you are stretching your monthly budget with your current payment, you can refinance your car loan to a longer term. By extending your repayment term, your monthly payments will decrease — but you will likely pay more in interest over time.

The bottom line: The key to knowing if refinancing your vehicle is the right choice is whether you will save money. If you can’t get a lower interest rate through refinancing, it is not a great idea. Refinancing to a higher interest rate will make your loan more expensive even if your payments are lower each month.

2. Review your current loan

You will need to know your payoff amount when you refinance. Most lenders have a minimum amount that they will lend. If your payoff amount is under the lender’s minimum, you won’t qualify.

But it is also important to understand exactly how much interest you have been paying, what your monthly payment is and what the total cost of the loan will be if you finish the entire term. Refinancing at a lower rate could save you money, but you won’t know for sure if you don’t know your current rate.

The bottom line: Education is power when it comes to getting the best deal. Take advantage of an auto loan calculator to understand how much you are paying on your existing loan and compare it to your refinance options once you apply for preapproval.

3. Check your credit score

Your credit score and history is a major factor lenders consider when you apply for refinancing. If you have made smart money decisions since then — paying down your credit card debt and making on-time payments, for example — your credit score may have improved. Lenders will view you as less of a risk and may offer you better rates.

Check your credit score before you start applying. This will help guide you toward lenders you qualify for and predict potential rates. Even those who have bad credit may still be able to get a loan with a lower rate by finding the right lender.

The bottom line: The better your credit score, the lower interest rate you will likely receive from a lender. Ultimately, it depends on both your score and your payment history.

4. Estimate the value of your car

The cost of your loan isn’t the only factor to consider when thinking about whether to refinance. You will also want to get a sense of what your car is worth. To do this, you can use resources like Kelley Blue Book and Edmunds.

If your car is newer with low mileage and a sizable balance that will still take years to pay off, refinancing could save you money and prevent you from going upside-down on your loan. If it’s worth less than what you owe, you may be out of luck.

And if your vehicle is almost paid off, it makes less sense to refinance since interest currently makes up a small portion of your remaining payments.

The bottom line: Knowing the value of your car can help you determine whether lenders will be willing to refinance. If your vehicle isn’t worth much, refinancing could cost you more money than you’d save.

5. Shop around for the best refinancing rates

All lenders weigh your credit score, financial history and eligibility differently. If you decide to refinance, start with the bank or credit union you use for other services. Some financial institutions offer discounts on interest rates for existing customers. Then compare the rate offered by your current bank with rates from other lenders to get a clear view of what top lenders are offering.

When you are ready, get prequalified with at least three lenders. It only counts as one inquiry on your credit report if you apply to multiple lenders within two weeks, and with multiple preapproval offers you can see which option is the best for your financial goals.

The bottom line: Interest rates vary widely, so compare a few lenders before deciding. Shop around — but be sure to check your current financial institution since there may be discounts for current customers.

6. Determine your savings

After you have shopped around for rates and understand what you may be able to qualify for, do the math to see how much you would save by refinancing your car loan. Just like when you reviewed your current loan, use an auto loan refinance calculator.

Check your current loan for fees. It is not uncommon for lenders to charge a prepayment penalty, which will make it more expensive to refinance.

You should also be clear on your goals. If you are looking to lower your monthly payment, make sure the new loan won’t cost too much more if you are opting for a longer repayment term. If you are refinancing at a lower rate, make sure that you are saving money on interest.

The bottom line: Doing the math ahead of time will let you see how much money a new rate could save you in terms of interest, monthly payments or both.

7. Get your paperwork in order

Preapproval is important, but it’s not the end of the process. You will need to gather the documentation the lender requires, like proof of income, proof of insurance and details of your existing loan.

Be prepared to show W-2s, pay stubs, utility bills, insurance cards and more. You will also need to have your vehicle’s make, model, mileage and VIN ready. It can mean a lot of paperwork, so be prepared to go over things and double-check for errors.

And once you submit the paperwork and get full approval, follow up with both lenders. If you receive a check, ensure that your previous lender receives it and applies it to your loan. If your new lender is paying off the old one, follow up frequently to avoid missing payments due to clerical errors.

The bottom line: Organize your documents ahead of time to speed up the refinancing timeline. Be prepared to spend some time contacting both lenders once you’re done to see that your new loan is going to the right place.

Factors to consider before refinancing

Lender requirements, additional loan fees and your finances should all be considered before you refinance your vehicle.

  • Requirements for refinancing: Every bank or lender has its own criteria to determine if you are eligible for refinancing. Be sure that you are not upside-down on your loan and are current on the payments. The amount of time left on your loan is another eligibility requirement. Lenders will often want to see at least six months of payments on your loan and have at least six months remaining.
  • Prepayment penalties: Many auto loans include clauses specifying how and when you can pay off the loan. Often these clauses include a prepayment penalty, which is a fee that must be paid if you pay off the loan early. Not all lenders charge this, but it could affect your overall savings.
  • Time remaining on the loan: If you are near the end of your current loan, it may make more sense to finish paying it off instead of sinking time and money into refinancing.
  • Your financial state: Your debt-to-income ratio is one of the many factors considered by lenders. The more debt you are able to pay off before applying for a new loan, the better terms you receive will be. You can use an online calculator to help determine what your debt-to-income ratio is.

Next steps

Refinancing your car loan can make a significant difference to your personal finances. If you are thinking about refinancing, investigate auto loan rates and compare those terms with the terms of your current loan.

By shopping around and working on improving your credit score if needed, you may be able to reduce the total amount you pay or get a more affordable monthly payment by switching lenders.

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