Refinance a Car Loan: 7 Situations When It Might Make Sense

There are times when refinancing a car loan isn’t the best move financially. However, don’t discount the idea entirely.

There are several situations in which refinancing your car is the right move to make, like if interest rates have dropped or your credit score has improved.

Context is everything. Let’s look at some cases where refinancing makes sense — and a few times where it probably doesn’t.

refinance car loan
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How to refinance a car loan?

Refinancing your car loan is often easier than you might think. Online lenders are likely to offer better rates but your local bank or credit union may have attractive promotional rates as well.

Whether online or local, there are a few simple steps you’ll need to navigate on your way to a new auto loan.

Check for a prepayment penalty

Some auto loans charge a penalty for paying off the loan early. Not all states allow the practice and you’re more likely to find a prepayment penalty on a short-term loan, but you’ll want to check for early payment fees.

Most auto loans charge simple interest, which means they are less costly than credit cards.

It also means that lenders are eager to protect their profit earned from the interest you pay.

Check your loan paperwork to see if there’s a prepayment penalty. If there’s a penalty, know how much it costs before making a decision on refinancing.

Investigate other fees

Prepayment fees aren’t the only potential cost to refinancing. It’s likely that 2 other fees could apply.

You’ll probably pay a fee to transfer the lien holder, which is usually less than $10. Re-registration fees may also apply, which can vary from state to state.

These 2 fees usually add up to less than $100, but it’s worth knowing the costs, especially if the savings from the new loan aren’t significant.

How much equity do you have in your car?

Much like with home buying, you build equity in a vehicle as you pay down the car loan.

However, cars depreciate rapidly in the early years of ownership and it’s possible that you owe more than the car is worth.

This situation is called negative equity and it can make it difficult or even impossible to refinance your car. The car acts as collateral for the loan, so many lenders won’t lend more than the car is worth.

Your credit score can play an important role in whether a lender will lend more than the car’s value.

If you have negative equity in your vehicle, waiting until you’ve paid down the loan further may be the best route.

Know your reasons for refinancing

Some people refinance to reduce their monthly payments. Others refinance to reduce the amount of interest they pay over the course of the auto loan.

Knowing your goals is important and can help guide you to the right refinance loan.

A lower interest rate might not always lead to lower interest costs over the life of the loan.

The loan length has to be considered as well. However, if your goal is to reduce your monthly costs, a longer loan term may be the way to go.

Compare rates and terms

There’s a good reason you want to compare rates after you’ve looked into other factors, like equity and fees.

When you complete an application for a refinance loan, lenders make a hard inquiry on your credit report, which means a request for new credit.

Expect your score to drop a bit after a hard inquiry. The good news is that if there are multiple inquiries within a short time period for the same type of loan, the impact of each inquiry is minimized.

In effect, the inquiries are lumped together to make the credit ding a bit smaller.

Some lenders offer a way to pre-qualify for a new refinance loan. When you pre-qualify, there is no impact to your credit score.

If decide to proceed with the application, the lender will then do a hard inquiry. The rate and term length can make a big difference when refinancing your car.

Experiment with quoted rates and loan lengths using an online calculator or spreadsheet to decide if a refinance offer makes sense. Maybe it’s a great deal, or maybe you should keep looking.

Know your monthly payment and payments remaining

Refinancing is all about the math. Your original loan payment was based on the amount you borrowed, the loan length, and your credit score.

To know what your savings will be if you refinance, you’ll need to know both your monthly payment and how many payments you have remaining.

A new loan may have a lower monthly payment but if the term is longer, you might pay more in interest with the refinance loan.

You’ll need real numbers from your loan statement to help you decide if a refinance offer makes sense.

Paperwork you’ll need

For the application and to move forward with the refinance offer, you’ll need a few basic documents. The lender will need your personal info such as name, address, and Social Security number.

They’ll also need proof of income. You may have to provide a pay stub or tax return to verify your income. Insurance is a must, so if you’ve been considering changing insurers, it might be a good idea to wait until after you secure the loan to make any insurance changes.

To complete the refinance, you’ll need the make, model, and VIN for your car. Your new lender can find your loan info and payoff amount electronically. However, it can be helpful to locate the paperwork for your original loan to verify everything is correct.

When should I refinance my car loan?

There are times when refinancing is the best move and there are times when you may be better of waiting a bit. Here are some situations in which refinancing can be beneficial.

1. Interest rates are dropping

Auto loans used fixed interest rates but interest rates for new loans go up and down all the time, changing based on several economic factors. If there’s a gap between the original loan rate and the rate for the refinance offer, refinancing can make a lot of sense.

Depending on the loan balance and the term of the loan, the difference in interest rates doesn’t even need to be that large to see a big savings.

For example, if you have a $18,000 balance with 48 months remaining at 5%, you can save about $8 per month and nearly $400 total by refinancing at 4%.

Lenders are required to provide the annual percentage rate (APR), which includes other borrowing costs, like fees. Be sure to compare the APR to understand the true costs when shopping for a loan.

2. Your credit score has improved

The interest rate for your original auto loan was based on your credit score at the time.

If your credit score has improved since you got the first auto loan, it may be time to shop for a better deal with a refinance loan.

For example, someone with a credit score in the low to mid 600’s might pay nearly 10% in interest for a new auto loan.

Fast forward a year or two and maybe that person has a credit score of 700. Rates might be as low as half with the improved credit score.

Refinancing a $18,000 loan balance that has 48 months remaining at 10% saves $50 per month if the new loan is at 5%. That’s a savings of more than $2,400 over 4 years.

3. You need lower monthly payments

There are 2 ways to reduce your monthly payments by refinancing. A lower interest rate will reduce your monthly payment as well as the overall cost of the loan.

Extending the loan term can also reduce your monthly payment. Here are some examples. A 60-month new car loan for $25,000 at 6% interest has a monthly payment of $483.

After a year, the remaining balance is $20,580. Refinancing the balance at 4% saves about $20 per month. Refinancing for 60 months reduces the monthly payment by $85.

However, if the interest rate is still 6%, you’ll pay an additional $671 in interest because the old loan only had 48 months remaining compared to 60 months for the new loan.

4. You want to get a better deal on your car loan

When buying a new car, many people let the dealer handle the financing. That’s understandable. After all, it’s easier.

The dealer’s finance offer may not be the best deal, however, and it may be worthwhile to switch.

Refinancing with your local bank or credit union can be a good local resource. However, online banks often offer lower borrowing costs.

5. You want to pay down your auto loan faster

Another option you have when refinancing is to reduce your loan term. Let’s say you have 48 months remaining on a 60-month auto loan.

If you refinance with a 36-month loan, you’ll pay the loan off faster — and you may even earn a better interest rate. Interest rates tend to be higher for longer loans.

If your original loan was for $25,000 at 5% interest, your monthly payment is $472. After 12 months of payments, your balance is $20,486.

Refinancing with a 36-month loan can reduce the amount of interest you pay overall, but your monthly payment amount will be higher.

Refinancing the $20,486 balance at 4% for 36 months gives you a monthly payment of $605. However, over the course of the loan, you’ll save $870.

6. You want to buy the car that you are leasing

With many of today’s leases, the residual value of the vehicle can be high. The cost of buying the car you were leasing may still be a good deal, though, and it’s a car you know well.

If you have the cash to buy the car outright, that’s an option. However, with interest rates so low, refinancing the car might be the best way to go.

The dealer can usually arrange financing but you might find a better deal by shopping around.

Expect your monthly payments to be higher than the lease payment in most cases.

The good news is that you’ll own the car and once the car is paid off, you won’t have a car payment.

7. You want to remove or add someone as a co-signer

If you had a co-signer for your loan or a car loan with a spouse, there might be a time when you no longer want that person to be responsible for the loan.

A lender won’t simply remove someone from a loan obligation due to divorce or another reason.

The best solution in this situation might be to refinance. In many cases, you just might save some money in the process.

Refinancing your auto loan in numbers:

If you’re considering refinancing, it’s helpful to understand the real-world numbers. Sure, you can save money, but how much can you save?

Lower interest rates

To calculate your savings, you need to consider the original loan amount, the interest rate, and how many payments you have remaining on your loan.

The loan payment you have is based on these numbers. Over time, the balance goes down but the monthly payment stays the same.

The monthly payment gives you a fixed point of comparison. For example, if you financed a new car for $35,000 at 6% with a 60-month loan, your monthly payment is $677.

After 12 months of making payments, your balance is $28,812. The monthly payment hasn’t changed, however, so you’ll be paying $677 per month for the next 48 months.

With the original loan, you’ll pay $32,496 over the next 4 years. Now, let’s look at some different interest rates and see how much you can save.

Loan balance after
12 months $28,812
Loan term
48 months
Interes
savings
Loan refinancing
@ 5%
$664$628
Loan refinancing
@ 4%
$651$1251

With a refinance loan at 5% for 48 months, your monthly payment drops by $13 per month to $664.

This might not sound like much but over the course of the loan, you’ll save $628 in interest. Refinancing the loan at 4% saves even more money.

With a 4% 48-month refinance loan, your monthly payment drops to $651. You save $26 per month.

Over the course of the loan, you’ll save $1,251 in interest. You can probably think of some better uses for $1,200 than paying interest.

Lower monthly payments

If you can get a better interest rate, your payments will probably be lower, depending on the loan term.

You can also lower your monthly payments by extending the term. One thing to watch out for is that if your interest rate isn’t lower, refinancing for a longer term will cost more in interest.

Let’s revisit the 60-month 6% purchase loan for $35,000. The monthly payment for this loan is $677.

After 2 years, the balance is $22,242 and there are 36 payments remaining.

Here’s what the payment becomes if you refinance without a change in interest rate:

Loan balance after
24 months $22,242
@ 6%
Loan term
48 months
Loan term
60 months
Loan term
72 months
Monthly
payments
$ 522$430$369
Monthly
savings
$155$247$308
  • 48 month term: Your monthly payment is $522, $155 lower.
  • 60 month term: Your monthly payment is $430, $247 lower.
  • 72 month term: Your monthly payment is $369, $308 lower.

A longer loan term is best paired with a lower interest rate. For example, without a lower interest rate, refinancing with a 60-month loan will cost $1,442 in additional interest.

Even though the monthly payment is lower, you’ll be making payments for a longer duration. You’ll also find that longer loan terms, like 72 months, may not be available in all cases.

When you should not refinance a car loan

There are times when refinancing doesn’t make as much sense. In some cases, it may not even be possible.

Upside-down loan

If you owe more than the car is worth, this is called being upside-down in the loan and you may have some trouble finding a lender who can write the loan.

Remember, your car is collateral for the loan. In most cases, lenders will require collateral that is equal of higher in value to the loan amount.

Older or high-mileage car

Many lenders limit loan availability based on the age of the car or the mileage. Some lenders only finance cars that are 7 years or newer.

Others may be more liberal and extend the age limit to 10 years. Mileage can be a factor as well. Lenders see high-mileage cars as a bigger risk. Expect to find fewer finance options as the mileage gets higher.

Your interest rate is low or at 0%

Refinancing is all about the numbers. You’ll see the greatest savings when moving from a high interest loan to a low interest loan.

Moving from one low interest loan to another isn’t likely to save much money. If you need to lower your payments by extending the term, however, refinancing a low-interest loan may still make sense.

Q&A about refinancing a car loan:

When is the best time to refinance a car loan?

In most cases, the best time to refinance is within the first year or two of buying the car. You’re more likely to earn a favorable rate if you have a good payment history or good credit.

Additionally, waiting too long can reduce the value of refinancing because you won’t save as much in interest.

Where can I refinance my car loan?

Your local bank or credit union can be a good source for a car refinance loan. However, many of the best rates are found through online lenders who may have lower operating costs.

What do I need to refinance my car?

You’ll need proof of income, proof of residence, and proof of insurance. You’ll also need your vehicle information.

This includes the make and model of your car and the VIN. Keep information about your current loan handy as well, including the payoff amount.

How soon can you refinance a car loan?

If you’re a first time borrower or have less-than-perfect credit, it’s often best to wait at least a year before refinancing.

This gives you a chance to earn a better rate based on improved credit and a solid payment history.

If you have good credit, you’ll find offers to refinance as early as 6 months. Some lenders may even send refinancing offers immediately after purchase if you have good credit.

How many times can you refinance a car loan?

There is no limit to the number of times you can refinance. As the vehicle ages and mileage increases, you may find fewer lenders willing to provide a refinance loan, however.

What happens when you refinance a car loan?

The lender who provides your refinance loan pays off the old loan and you begin making payments to the new lender according to the agreed rate and term.

As part of the process, the new lender has to be listed on the title for the car. It’s also important to change the lienholder listed on your insurance policy. 

What credit score do you need to refinance a car loan?

In many cases, you can get an auto refinance loan even if you have a lower credit score. However, rates will be more attractive if you have average to excellent credit. Another thing lenders look at is debt-to-income ratio.

In addition to your credit score and payment history, lenders pay attention to whether you make enough to pay your debts.

How to refinance a car loan with bad credit?

Many lenders don’t lend to consumers with troubled credit. However, there are a number of lenders who specialize in bad credit loans and can work with you to refinance your car.

Expect to pay a higher rate than if you have good credit. In many cases, it may be helpful to work toward repairing your credit and building a solid payment history so you can earn a better interest rate.

Does refinancing your car loan hurt credit?

Refinancing doesn’t hurt your credit in a meaningful way. You will see a small drop in your credit score due to the request for new credit. You may also see a small drop in your score based on the average age of credit accounts.

The new loan replaces the old loan in some credit scoring models, which reduces the average age of your credit accounts. If you maintain good credit habits going forward, any effects to your credit score will be short lived.

How to avoid prepayment penalty for an auto loan?

Prepayment penalties can cost 1% of the loan balance. Unfortunately, you often can’t avoid the penalty. Your loan is a contract.

Weigh the cost of the prepayment penalty against the savings you’ll see from refinancing. In most cases, the savings still make refinancing a good financial move.

Refinancing a car loan could save you thousands of dollars

Refinancing your car is worth the effort in many cases. Even if the monthly savings seem small, those nickels and dimes can add up to big savings over time.

The average new car costs over $37,000. How much can you save if you can get a loan at a lower rate? For many households, the savings could be thousands of dollars over the course of the loan.

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