What Is Auto Loan Refinancing?

Refinancing your auto loan involves replacing an existing car loan with a new one, often with a lower interest rate or more favorable terms. This strategy is often used to reduce monthly payments and manage finances more effectively. By refinancing, you could potentially save a significant amount of money over the life of the loan.

As with most loan products, auto loan refinancing comes with eligibility requirements. Lenders will look at your creditworthiness to determine the terms of your new loan. Having an improved credit score since your original loan was taken out could mean you're eligible for a lower interest rate.

TABLE OF CONTENTS

Types of Auto Loan Refinancing
Pros and Cons
When to Refinance Your Auto Loan
How to Refinance Your Auto Loan
Alternatives to Refinancing
FAQs

Types of Auto Loan Refinancing

Auto loan refinancing comes in two forms: traditional refinancing and cash-out refinancing. Each comes with its own benefits and considerations. Understanding these types can help you choose the option that best aligns with your financial goals and circumstances.

Traditional refinancing

Traditional refinancing involves replacing your existing auto loan with a new one. This is often done with a different lender, but it's also possible to refinance with your current one. The primary goal of traditional refinancing is to secure better loan terms. This could mean obtaining a lower interest rate, which can save you money over the life of the loan and potentially reduce your monthly payments. Alternatively, you might refinance to adjust your loan term.

Cash-out refinancing

With cash-out refinancing, you take out a new loan for more than you owe on your current auto loan. The lender pays off your existing loan and gives you the difference in cash. This can be a beneficial option if you have equity in your car, meaning your car is worth more than the remaining balance on your loan. It’s worth noting, however, that with cash-out refinancing, you're increasing the amount of your loan. This could result in higher monthly payments and more interest paid over the life of the loan.

Pros and Cons of Auto Loan Refinancing

Auto loan refinancing can offer several advantages, such as lower interest rates and reduced monthly payments, potentially leading to significant savings. However, it also comes with potential drawbacks, including possible fees and the risk of extending the loan term, which could result in paying more interest over time.

Before applying for auto loan refinancing, weigh its pros and cons to make an informed decision that aligns with your financial goals.

Pros of Refinancing Your Auto Loan

Lower interest rate: If your credit score has improved since you took out your original loan, you may qualify for a lower interest rate. A lower interest rate can save you a significant amount of money over the life of the loan.
Reduced monthly payments: Refinancing can lower your monthly payments, either by securing a lower interest rate or extending the loan term. This can free up cash for other expenses or financial goals.
Change in loan term: Refinancing allows you to adjust the length of your loan. You could either choose to shorten the loan term to pay off your debt faster or extend it to reduce your monthly payments.
New lender: If you're unhappy with your current lender — for instance, due to poor customer service — refinancing allows you to switch to a different lender who better meets your needs and expectations.
Extra cash: If you have equity in your car (meaning the car is worth more than you owe), you may be eligible for a cash-out refinance. This allows you to get a loan for more than you owe and receive the difference in cash.

Cons of Refinancing Your Auto Loan

Prepayment penalties: Some auto loans have prepayment penalties, which are fees you incur for paying off your loan earlier than the agreed term. If your original loan has a prepayment penalty, you'll be charged a fee for paying off your loan early with a refinance.
Transaction costs: Refinancing a loan often involves various fees, including origination fees and potential transaction fees. These costs could add up and offset the potential savings from a lower interest rate or reduced monthly payments.
Potential credit impact: When you apply for a new loan, lenders typically perform a hard credit inquiry to assess your creditworthiness. This can temporarily lower your credit score and potentially hurt your eligibility or interest rate for other forms of credit.
Extended loan term: Extending the loan term can lower your monthly payments, but this means you'll be in debt for a longer period. Over time, you could end up paying significantly more in interest, offsetting the benefits of lower monthly payments.

When to Refinance Your Auto Loan

Refinancing your auto loan can be a strategic financial move, but the timing and circumstances need to be right to make the most of it. Here are some situations where refinancing your auto loan could be a beneficial decision.

Your credit score improved

If your credit score has significantly improved since you took out your original auto loan, refinancing could be a good idea. Lenders base loan terms, particularly interest rates, largely on your creditworthiness. With a higher credit score, you're likely to qualify for a lower interest rate, which could save you money over the life of the loan.

Lower interest rates are available

Even if your credit score hasn't changed, you might find that interest rates have fallen since you took out your loan. In this case, refinancing could help you take advantage of these rates. A lower interest rate can reduce your monthly payments and the total amount of interest you pay over the life of the loan.

You’re facing a financial hardship

If you're facing financial difficulties, refinancing your auto loan to extend the loan term can lower your monthly payments, freeing up cash for other expenses. However, it's important to remember that extending the loan term can result in paying more interest over time.

Your financial situation has changed

If your financial goals or situation have changed, you might want to refinance to adjust your loan term. For instance, if you're now earning more and want to pay off your loan faster, you could refinance to a shorter loan term. Conversely, if you need to reduce your monthly expenses, you could refinance to a longer loan term to lower your monthly payments.

You want to switch lenders

If you're unhappy with your current lender, perhaps due to poor customer service or inconvenient payment methods, refinancing allows you to switch to a different lender. It's important to be satisfied with your lender, as you'll be dealing with them for the duration of your loan.

When to Hold Off on Refinancing

While refinancing your auto loan can offer several benefits, there are situations where it might not be the best decision. Knowing when to hold off on refinancing can save you from potential financial pitfalls and ensure your loan aligns with your long-term financial goals.

Your car is old or has high mileage

Many lenders have restrictions on refinancing older or high-mileage vehicles. If your car falls into these categories, you may find your options for refinancing are limited or non-existent.

You’re underwater on a loan

If you owe more on your car than it's worth, it means you’re in a situation known as being “underwater” or “upside down” on your loan. This might make it difficult to qualify for a refinance, or you may not save money by doing so. In this case, it might be better to focus on paying down the existing loan.

You’re close to paying off your loan

If you're nearing the end of your loan term and have only a few payments left, refinancing might not make sense. The potential savings from a lower interest rate or reduced monthly payment may not be significant enough to justify the costs and effort of refinancing.

Your credit score has taken a hit

If your credit score has dropped since you took out your original loan, you may not qualify for a lower interest rate. In fact, refinancing could potentially result in a higher interest rate, which would increase your costs.

How to Refinance Your Auto Loan

The following steps will help you navigate the auto loan refinancing process effectively.

1
Review your current loan
Start by understanding the terms of your current loan. Know your current interest rate, the remaining balance and the number of payments left. You should also check if there are any prepayment penalties or fees associated with paying off your loan early. This information will serve as a benchmark for comparing potential new loan offers.
2
Check your credit score
Your credit score plays a significant role in the kind of terms you can secure with a new loan. If your credit score has improved since you took out your original loan, you're more likely to qualify for a lower interest rate. You can check your credit score through various online platforms, some credit card issuers or directly from the credit bureaus.
3
Shop around
Don't settle for the first offer you receive. Take the time to compare loan terms from different lenders to find the best deal. Online tools and calculators can be particularly helpful in this process, allowing you to see how different interest rates and loan terms could affect your monthly payment and the total amount paid over the life of the loan.
4
Apply for a new loan
Once you've found a lender with favorable terms, the next step is to apply for the new loan. This usually involves providing information about your income, employment and the vehicle. Be ready to provide documentation to support your application, such as pay stubs, tax returns and information about your vehicle.
5
Close the deal
If your application is approved, the new lender will pay off your existing loan, effectively transferring the debt from the old lender to the new one. You'll then start making payments to the new lender under the agreed-upon terms. Make sure you understand all the terms of your new loan before you sign the dotted line.

Alternatives to Auto Loan Refinancing

While refinancing can be a great way to lower your auto loan payments or reduce your interest rate, it's not the only strategy available. The following alternatives can also help you manage your auto loan more effectively.

Negotiate with your lender

If you're facing financial hardship and struggling to make your monthly payments, try negotiating with your current lender. They may be willing to adjust your payment schedule, give you a temporary payment break or even reduce your interest rate. It's in their best interest to help you continue making payments, so it's worth discussing your options.

Pay more than the minimum requirement

If you're looking to pay off your loan faster and save on interest, consider making more than the minimum payment each month. This can help you reduce your loan balance more quickly, which in turn reduces the amount of interest you'll pay over the life of the loan. Just make sure your loan doesn't have any prepayment penalties before taking this approach.

Sell your car

If your monthly payments are too high, it might be worth selling your car and buying a less expensive one. This could help you reduce or eliminate your auto loan debt. Just be sure to consider all the costs associated with buying and selling a car, including taxes, registration fees and potential depreciation.

Use a home equity loan or line of credit

If you own a home and have enough equity, you might consider using a home equity loan or line of credit to pay off your auto loan. These types of loans often have lower interest rates than auto loans. However, remember that your home will be used as collateral, so there's a risk of losing it if you can't make the payments.

Frequently Asked Questions

To help you navigate the auto loan refinancing process, we've compiled a list of frequently asked questions about refinancing an auto loan.

What factors do lenders consider when you apply for a refinance?

Lenders typically consider factors such as your credit score, income, employment stability, debt-to-income ratio and the value of the car.

Does refinancing hurt your credit score?

Refinancing can temporarily lower your credit score due to the hard credit inquiry that lenders perform. However, making your payments on time and in full on your new loan can help improve your credit score over time.

Can you refinance if you’re underwater on your auto loan?

Being underwater can make it more difficult to refinance, as lenders may be hesitant to refinance a loan when the car is worth less than the loan balance. However, some lenders do offer underwater refinancing, so it's worth shopping around.

Can you refinance your auto loan more than once?

Yes, you can refinance your auto loan more than once. However, it's important to consider the potential impact on your credit score, as well as any fees associated with refinancing, before deciding to do so.

How long does it take to refinance an auto loan?

The time it takes to refinance an auto loan can vary widely, but it typically takes a few days to a few weeks. This includes time for shopping around, applying for the loan and closing on the new loan.

About Christopher Boston

Christopher (Croix) Boston was the Head of Loans content at MoneyGeek, with over five years of experience researching higher education, mortgage and personal loans.

Boston has a bachelor's degree from the Seattle Pacific University. They pride themselves in using their skills and experience to create quality content that helps people save and spend efficiently.

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