Refinancing an auto loan means you swap one loan for another. Usually, people refinance to get a better interest rate or lower their monthly payments. Depending on the terms of your new loan, you might be able to effectively start the loan over.
In this guide, we’ll explain the basics of refinancing a car loan, including how and when to refinance, and when other options may be a better choice.
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What Is Refinancing?
Refinancing means exchanging your existing car loan for a new one, typically from a different lender. Once you’re approved, the new lender issues payment to your existing lender, which replaces your auto loan.
Refinancing an auto loan allows you to get more favorable terms. If you can find an auto lender with lower interest rates than you currently have, you could save a lot of money over the life of the loan.
How Does Refinancing Work?
When you refinance, you take out a new auto loan that pays off your previous one. Refinancing an auto loan requires you to submit a new application, which requires a hard credit check. You’ll need to make another down payment and pay loan fees. Your existing lender may also charge a prepayment penalty fee for paying off your original loan early.
Refinancing an auto loan may also affect your credit score by closing an existing account, opening a new account, and adding a hard inquiry to your report. For this reason, it’s usually a good idea to review the costs associated with refinancing and check your credit score to ensure that refinancing is a good option for you.
Reasons to Refinance an Auto Loan
Some of the most common reasons to refinance an auto loan include:
- To qualify for a better interest rate: If your credit score has increased or interest rates have gone down since you last applied for an auto loan, refinancing could help you secure a more favorable interest rate.
- To reduce your monthly payments: Refinancing an auto loan can result in lower monthly payments. If you refinance for a longer loan term, you pay what you still owe over a longer period of time. However, remember that this strategy may lead to paying more interest over the duration of your loan.
- To remove a cosigner from the loan: You can refinance if you want to remove a cosigner from your auto loan. You may want to do this if the cosigner’s credit score has decreased or if your financial situation has improved enough to get approved on your own.
- To add a cosigner to your loan: Refinancing also allows you to add a cosigner to your auto loan if you don’t already have one. This could help reduce your interest rate if the cosigner has an excellent credit score.
Does Refinancing Start a Loan Over?
Refinancing doesn’t necessarily start your loan over. Instead, refinancing replaces your existing auto loan with a new one, where you can choose the terms that best fit your needs and budget. For example, if you have 24 months left on your current loan, you could choose a new two-year loan so you don’t extend the time until your car is paid off.
However, remember that a shorter loan term usually results in higher payments. A longer-term loan usually has lower monthly installments, but you’ll pay more interest and make more payments in total. But if you want to reduce your monthly payments and you don’t qualify for a lower interest rate, you can always choose a longer-term loan than you currently have.
How to Refinance an Auto Loan
If you decide that refinancing your auto loan is the best financial decision, here are the steps you should follow:
1. Request a Payoff Quote
Before applying, you’ll want to request a payoff quote from your lender. This quote includes all fees the lender charges for paying off your auto loan early. A payoff quote also ensures you’re eligible for refinancing. For example, some lenders may not allow you to refinance within the first six months of vehicle ownership.
Reviewing your current interest rate and comparing it against market rates can help you find the most favorable terms.
2. Compare Lenders
Compare multiple lenders to find the best one for your situation. Lenders weigh factors such as credit scores differently, so looking around for the best rates is important. Make sure you consider not only the interest rate but also the length of the loan. A higher interest rate on a shorter-term loan may be more affordable than a low interest rate on a longer-term loan.
You can use an auto loan calculator to plug in your loan terms, interest rate, and down payment to determine exactly how much you’ll pay. Comparing a refinanced loan with your current one is an excellent way to determine how much you’ll save or pay to refinance your auto loan in the long term.
3. Consider Your Financial Situation
Refinancing an auto loan is similar to applying for a new loan. The new lender will check your credit score and make financing decisions based on your debt-to-income (DTI) ratio and credit history. Try not to open new lines of credit or miss payments on existing accounts before applying for refinancing. Avoiding high credit card balances can also help you maintain a good credit score and potentially qualify for a better interest rate.
Then, determine how much money, if any, you’ll put down on the new auto loan. Some auto lenders may require a minimum down payment, whereas others allow you to choose your amount. Typically, the more you can put down on your purchase, the lower your monthly payments will be. Additionally, financing a lower amount means you’ll pay less interest over the loan term.
This is also a good time to get an updated copy of your credit report. A good to excellent credit score is usually a requirement to qualify for low interest rates. You can get a free credit report from Equifax, Experian, and TransUnion once per year.
4. Choose Your Loan Terms
Most auto loans are somewhere between 24-84 months. Your monthly payments on an 84-month loan will be less, but the total costs will probably be higher. Choosing a 24-month loan may mean higher monthly payments, but you’ll pay less interest overall and be finished with the loan much sooner.
Another important consideration for your loan term is the type of interest rate. A fixed-rate car loan means you’ll pay the same monthly payment for the life of the loan unless you refinance. A variable-rate car loan means your monthly payments may change, resulting in higher payments toward the end of the loan.
5. Sign and Transfer Your Loan
Once you choose a new lender to finance your auto loan, you can sign the necessary paperwork and transfer your loan. Most lenders will handle all the paperwork on your behalf. Some may issue a payoff check to you, which you then send to your original lender. Other lenders may send the payoff amount directly to the original lender.
Once the loan closes, you’ll make monthly auto payments on the new loan based on the new terms. Your old loan is closed and will show as paid off on your credit report.
When You Shouldn’t Refinance an Auto Loan
Just as there are benefits to refinancing an auto loan, there are a few situations in which you shouldn’t refinance, including:
- Interest rates have increased: If market conditions cause interest rates to go up, it may not be the best time to refinance your auto loan. Compare your existing interest rate with market average rates to determine if a lower rate is possible. You typically won’t receive your specific interest rate until you apply with the lender.
- You have less than two years left on your auto loan: Restarting your auto loan with less than 24 months left may result in paying more for your car. Extending your auto loan beyond two years may also lead to negative equity, which is when you owe more on your vehicle than it’s worth. Negative equity can make it difficult to sell your vehicle, and your lender may require GAP insurance.
- Your credit score has decreased: If your credit score has gone down since you applied for your auto loan, it may be difficult to qualify for a lower interest rate and reduce your monthly payments.
- Your existing lender charges expensive penalties: Refinancing may also not be worth it if your lender charges expensive prepayment penalties. High fees can cut into the cost savings available with a refinancing loan.
- You’ll end up paying more for the vehicle: Restarting your auto loan can lead to paying more for the vehicle. Always calculate the total cost of interest paid and compare it to your existing loan to determine if it’s a good financial decision.
Alternatives to Refinancing an Auto Loan
While many good reasons exist to refinance an auto loan, it’s not the only option. Here are a few alternatives to refinancing an auto loan:
- Cash-out refinance: Although they’re typically more common with mortgages, some lenders offer cash-out refinance auto loans. A cash-out refinance allows you to take out a new loan that covers a greater percentage of your vehicle’s value than what you currently owe. In return, you’ll receive a check for the difference.
- Loan modification: Some lenders may offer a loan-modification program to borrowers struggling to make payments. This program may include deferred payments or a lower interest rate.
- Trade in your vehicle: A vehicle trade-in may help you avoid a difficult financial situation if you replace it with a vehicle that’s worth less. However, you’ll need to have already paid off more than your vehicle’s current value to trade it in without additional fees.
Refinancing an auto loan can start your loan over, but it doesn’t have to. Refinancing can also qualify you for a better interest rate, leading to a lower monthly payment. Considering the fees, current interest rates, and loan terms can help you decide if refinancing your auto loan is the best choice for your situation.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.