Disclosure regarding our editorial content standards.
You can save money by refinancing almost any type of loan if the price is right. It’s not for everyone, but after reading this guide, you’ll know whether you should consider refinancing your car loan.
The idea behind refinancing is simple: You take on a new auto loan with new terms, the new lender takes over your old loan and you (presumably) save money or benefit in another way with the new loan. It can even be done without long-term effects on your credit.
3 reasons to refinance your car loan
1. You could reduce your interest rate
Everyone wants to keep more of their money, and lower interest rates are almost always better. You’ll need to check for fees or conditions that may sour the deal, but generally it’s in your best interest to pay less of it. While you’re searching for deals on refinancing cars, houses, boats, planes and snowmobiles, the interest rate should be the main focus.
For example, according to Kelley Blue Book figures from 2020, the average price of a midsize car was $25,000. And interest rates can be anywhere from around three percent to just over 20 percent depending on a person’s credit and other factors. So let’s say you have great credit and you’re offered six percent interest over 60 months. That $25,000 car you financed will cost an extra $3,999 in interest over the five-year term.
Now, let’s try again with very poor credit—something that most lenders run from. You’re offered a loan at 20 percent interest over 60 months. In this case, you’ll pay an extra $14,741 in interest.
The difference is night and day. If you had bad credit when securing the loan and your credit has improved since then, you may benefit from refinancing. Likewise, if average interest rates have gone down since your deal, refinancing makes more sense.
2. You could decrease your monthly payments
If you refinance, it may be helpful to decrease the amount you pay each month, but that’s not always true. If it means extending the term of the loan, it could actually cost you more, although this may still be preferable if you need to save that extra money right now.
For example, let’s use the $25,000 car and six percent interest that we financed earlier. If we made that deal for 84 months instead—adding two years to the loan—the payments drop to $365 per month instead of $483.
Most people would love to be free of a loan sooner rather than later, but if your budget isn’t working for that shorter term, it may make sense to go longer. However, 84 months is about as far as you’d want to stretch it.
3. You could work with a new lender
If you want to switch lenders, it’s probably due to one of the above reasons. It’s just business, and saving money is more than enough reason to go your separate ways.
There are some other issues that could cause a split between you and the lender, however, such as the need to replace, remove or create a co-borrower arrangement. This lets you split the responsibilities of both the loan and car. You’ll both be registered on the title and loan agreement, which is great in many situations, but think about it carefully and assess the benefits, because you can’t drive half a car.
You might also want to switch lenders if your current loan owner doesn’t have good customer service or you don’t like interacting with them.
Things to consider before refinancing
Loan and car age
Technically, there’s no waiting period to stop you from refinancing a newly acquired loan. But it takes time for the title of the car to officially transfer to your name, so most people should expect to wait at least two to three months before seeking a refinance.
It’s not all that uncommon to act this early, but it’s generally not beneficial unless you have excellent credit. This is because other lenders simply won’t accept the application or will make offers that aren’t in your favor.
If you have average to good credit, refinancing may start making more sense at around six months. If it’s your first loan or you simply lack much of a recent payment history, it’s usually best to stay put for a year or longer.
On the other hand, lenders won’t be very excited to make a deal if you wait too long and your current loan is almost finished. They’re in it to make money as well, obviously, so a refinancing deal they offer toward the end of your loan will be less beneficial to you than it could’ve been.
The same is true for older cars. Refinancing doesn’t make as much sense—and you may be denied outright—because cars just don’t retain their value over time.
Lender requirements
Apart from the time-based depreciation we just covered, most lenders have a cutoff point for mileage. The specific number varies depending on lender, but if the car has over 100,000 miles, your choices begin to drop significantly. When you have fewer choices, your chances of securing a good deal also drop.
The mileage limits of each lender are generally set in stone, along with basic requirements such as proof of income and identity. However, they may let you slide on some other requirements if you have great credit, such as the down payment or personal references.
Loan-to-value ratio
This is similar to the issue of older cars we covered earlier. The loan-to-value (LTV) ratio refers to the dollar amount you owe compared to the amount you could expect to sell the vehicle for.
The LTV ratio affects mortgages as well, but it’s a bigger concern for auto loans due to the faster depreciation of cars. If you owe more than the purchase is currently worth, it’s called an upside-down loan, and this can be an issue when you’re looking for better deals via refinancing.
Prepayment penalties
Some lenders actually penalize you for giving them money too quickly, because they earn more when you pay it back slowly. Luckily, this is far less common in car loans than it is for home buyers, but it does exist, and you should check the terms to make sure prepayment penalties won’t offset the benefits of refinancing.
Any other fees
Check both the new and the old loan terms for processing fees—sometimes referred to as application or administration fees—and if your credit is good, ask whether they’ll waive it.
You may also have to pay for re-registering the car and/or a title transfer, which varies by state, and your insurance premium may increase.
The hard inquiry
Although refinancing your car loan shouldn’t (permanently) hurt your credit when it’s done properly, your score may take a short-term hit. This is because of the hard inquiry that comes from a lender checking your credit to determine your creditworthiness. The hard inquiry will show up as a negative item on your report for two years, but luckily, it shouldn’t hurt your credit much, and its impact will decrease as time passes.
Are you ready to refinance your car loan?
Applying for refinancing isn’t much different from the process you went through for your current loan. You’ll need the same documents—driver’s license, proof of income, vehicle identification number, Social Security number—and you should also know your credit situation so you know what kind of deal you can make.
If you’ve decided that you can benefit from a refinance and you’re able to make payments, start researching your loan options today. And if you want to try to improve your credit score before you apply for the refinance, the advisors at CreditRepair.com can help you out.
