How to Refinance a Car
A lot can happen after you purchase a new car. Your income may change, your credit score may shoot up after making monthly payments, or you may find you want to adjust your monthly budgeting.
Whatever the reason, at some point, you may consider refinancing your current auto loan to get better terms.
But is auto loan refinancing a good idea? Let’s take a closer look.
Refinancing an auto loan: A step-by-step guide
- Have a good reason to refinance your original loan
- Review your car loan for prepayment penalties
- Look at your credit score
- Compare different offers
- Assess the costs of refinancing
1. Have a good reason to refinance your original loan
Stop and think about why you want to refinance your car loan. Don’t just go in because someone told you it’s a good idea or because you read about it online. Take the time to understand your unique financial situation and understand whether it makes sense based on your needs.
Here are some of the top reasons why you may want to refinance your auto loan.
You want a lower interest rate
The best reason to refinance is to secure a better interest rate. Maybe you didn’t quite get the interest rate you hoped for when you bought your car, and you want to try again. It could be worth having a conversation with your current lender. Simply put, a lower interest rate is going to save you a ton of money throughout the length of the loan.
Your credit history has changed
Take a look at your credit score and see if it’s changed. Maybe when you got your car, you had a score that was good or average, and now your score is considered excellent by one of the major credit bureaus. If that’s the case, you may be able to save thousands over the length of your loan if you qualify for a lower interest rate.
You have less income
Another reason you may want to refinance is that you have less income than when you bought your car. Maybe you lost your job, got laid off, or had to take a pay cut. If so, you may not be able to afford your current car loan payments, and so it could be advantageous to explore new options.
Just keep in mind that your lender is going to take your new financial situation into account when you apply for a new loan. If you don’t have the same cash flow, you may not get the best refinancing rate. So proceed carefully before starting the refinancing process and consider finding more work first to increase your cash flow.
Check your other options
If this is your situation, consider picking up a second job, cutting spending in a different area, or selling your car and getting something cheaper that you don’t owe payments on. Of course, these options are not available to everyone. But if one of these strategies works for you, the outcome is better than taking on more debt by refinancing.
As I’ve said in the past, interest-bearing debt (including car payments and credit card balances) is the most common barrier to achieving financial freedom.
2. Review your car loan for prepayment penalties
It’s also a good idea to take a close look at your contract before moving forward. A car loan often contains hidden prepayment penalties. So you may get hit with unexpected fees when trying to terminate your agreement.
Make sure you thoroughly understand every detail in the fine print so you don’t stumble into any unexpected surprises.
After all, this is a legally binding contract you’re modifying, so you should do your due diligence.
Make no mistake about it: Lenders can be notoriously difficult to work with, especially when ending agreements. If you owe a lender money, you’ll most likely have to either pay it outright or roll what you owe into a new agreement.
3. Look at your credit score
Make sure your credit score is in a good place when you refinance. It’s possible your score may have decreased since you bought your vehicle if you didn’t make payments on time.
If your score isn’t where you need it to be, consider doubling down on your efforts to improve it before discussing refinancing with a different lender. If you can tough out your current loan for a few months and actively work to improve your credit score, you could significantly increase your chances of getting a better refinancing option.
4. Compare different offers
Once you decide to proceed with refinancing, don’t limit yourself to the lender you originally used.
Of course, there’s nothing wrong with approaching your car dealer and giving them the opportunity to make you a great offer. Just keep in mind you’ll be dealing with the financial institution that manages the dealer’s loans and not the dealer itself. So their finance department’s hands may be tied in terms of giving you a better financing option, even if you have a trusting relationship.
Once you get an offer from a lender, go to another dealership in your area and compare the loan rates. What they come back with will determine how competitive your refinancing options are.
Just keep in mind that each time you apply for a new auto loan, a lender will make a hard pull on your credit score, which stays on your credit report for up to two years. Hard credit pulls can knock a few points off your score. So if you have shaky credit to begin with, this could hurt you.
5. Assess the costs of refinancing
Before you go ahead and refinance a loan, make sure you have the cash on hand to pay for additional costs. You may have to pay to register the car again, or your insurance may change, or you may have to pay an application fee and origination fees, in addition to possible early termination fees.
Tips for a successful auto loan refinance
Understand you may get declined
Just because you receive an offer for a refinancing deal and want one, it doesn’t mean you’re guaranteed to get approval.
If your application gets rejected, keep a cool head and determine the next steps. Get serious about starting a side hustle to generate more cash or asking for a raise. You can also get serious about fixing your score and reapply again at a more strategic time.
Don’t get discouraged—you’ll get through it! And remember that all loan terms eventually come to an end.
Don’t rush into refinancing
You should also avoid rushing into a new deal until you’re completely comfortable with the offer you receive. Not all refinancing options are ideal.
The biggest drawback about refinancing your auto loan is that you’re likely to drag out the contract and pay more over time in interest fees. If you have the cash flow, it may be in your best interest to convert to a shorter-term loan with higher monthly payments so you can pay off the car faster and save money.
Remember that in some cases, especially if you’re upside down on the car loan, it may make better sense to tough out an existing loan and get through it, rather than dragging it out.
Consider selling your car
Instead of refinancing, you should seriously consider ditching your ride altogether if possible.
You may have to get creative or adjust your lifestyle. You may even take an immediate loss if you have to buy yourself out of the contract. But remember that cars only depreciate in value, so you are always going to take a loss, no matter what.
If you don’t need your car, it could make more sense to get out of the loan instead of restructuring it.
You could be able to buy out the remaining amount on the contract or even potentially exchange it for a used car that you could turn around and sell immediately. It largely depends on how much cash you have to play around with, and how much is left on the remaining balance for the total loan amount.
Getting out of your loan and ditching your car will save you gas, maintenance, and insurance. It could be a great decision if you can swing it.
Frequently Asked Questions
How do you refinance a car loan with bad credit?
If you have bad credit, you’re going to want to improve your score before going in and asking for a new rate. It’s going to be hard to secure a loan with a bad score. At the same time, applying for a loan may knock your rate down even further because the lender is going to do a hard credit pull.
With that said, there are probably still refinancing options for you, regardless of your credit score. In some cases, having a cosigner whose credit score is better than yours is enough to get approval. Just make sure you don’t sign up for a bad deal.
Unfortunately, borrowers with lower credit scores are likely to pay higher interest rates over the life of the loan compared to a borrower with a good credit score.
If you simply can’t get anywhere your current lender, you may have better luck with a personal loan, debt consolidation service, or a credit union.
How much does it take to refinance an old loan?
Every auto lender operates differently. Generally speaking, there is no standard amount you need to put down to refinance.
As for timing, it’s generally recommended to wait a few months, or even better, six months after securing the original loan, before applying. This is because you may get a better rate if you put at least a few months of payments in and demonstrate you have the ability to pay on time. This can show that you’re a trustworthy borrower who just wants to get a better deal, and new lenders may be more willing to work with you in this case.
How hard is it to refinance a car?
It largely depends on your unique set of circumstances. If you have a bad credit score, it’s very hard to refinance a car.
On the other hand, if your personal finance situation is in great shape, it might be easy for you.
Either way, take a close look at your budget and cash flow to determine exactly how much you can afford before applying for anything.
The Bottom Line
Refinancing a car loan is a big decision you shouldn’t rush through.
The most important factors are that the numbers add up in your favor and that you avoid taking on more debt than you can afford to pay back. While you can potentially get a lower monthly payment, you may also walk away with a longer term.
If you have good credit and think you can save money over the course of your loan, then it certainly makes sense to shop around.
Remember that loans can be a major barrier to financial success. In some cases, debt can help you get ahead, but it can also become a major burden and spiral out of control.
Here’s to finding the best loan terms for your car so that you have more money left over to save and invest. Good luck!