If you are unhappy with your current auto loan, you can quickly refinance it for a better one. Refinancing a car loan involves replacing your current loan with a new one with favorable terms. After refinancing your car, you will have a brand new loan with a lower interest rate, a different loan term, or both. In this post, I will show you how to refinance your auto loan step by step and tips to qualify for the lowest interest rate and better terms.
Before you refinance your loan, you must check if you qualify for the refinance and if this is a good option for you. You must have a good credit score to qualify for lower interest rates and better terms. Most lenders prioritize borrowers with stable incomes, on-time payment track records, and established credit histories. A higher DTI ratio can also hinder your chances of refinancing your car loan. So, pay off some of your debts before you refinance your loan.
This article will walk you through the process of refinancing your car loan.
How to refinance a car loan?
The process of refinancing a car loan is simple. You must evaluate your current loan and see if refinancing benefits you. You must also list everything you need in a new loan and find lenders who can offer what you need.
For example, if you applied for a car loan when market rates were higher compared to what they are now, you will need a lender who can offer you a much lower interest rate. Even if you qualify to refinance your auto loan, you must consider closing costs and related fees. If refinancing your car loan will not save you money, this process might not suit you.
The following are the steps you need to refinance a car loan.
1. Evaluate if refinancing a car is right for you
Before looking for a new loan, you must check if this is the right action. Your main goal is to save money on the car, lower your monthly payment, or have better terms. Refinancing your loan can help reduce your monthly charges if you struggle with higher monthly payments. As a result, you can easily afford to pay off the car.
Take advantage of lower interest rates.
- When buying the car, did you have bad credit and a lower credit score? If you have improved your credit score and rebuilt your credit, you can qualify for a much lower interest rate when you refinance your car loan.
- Interest rates have gone lower since you bought the car. You will sometimes buy a vehicle when market rates are higher due to a higher inflation rate. If interest rates have dropped since you purchased the car, you can refinance your car loan and take advantage of lower rates.
You can refinance your car loan to lower expenses if you struggle with monthly payments due to higher interest charges. Lower monthly payments on your auto loan will make it easy to pay off the car, reduce the cost of the vehicle, and help you pay it off faster.
You can also refinance a car for a longer term or shorter.
Refinancing your car loan is not all about saving money. Sometimes, it is all about lowering your financial stress level. You may have locked in a shorter term due to a stable income or had two jobs when you bought the car. Shorter terms come with much higher monthly payments. Back then, you could afford these payments without any problem. What if you have lost one of the jobs? Making monthly payments and meeting other financial obligations on the same income might be challenging.
If you cannot afford your monthly payments, consider refinancing your car loan for a longer term. This will result in a lower monthly payment and make the car affordable without working double shifts. The downside of this strategy is the increase in the cost of the vehicle due to holding the loan for a long time.
2. Understand your current loan payments and expected monthly payment after financing the loan
Locking in a new loan means that a lot of things will change. First, you must understand your current auto loan payments and how they compare with expected payments after refinancing your loan. For example, if you refinance a car loan for a much shorter term, your monthly payments will be higher than what you are used to paying.
To determine your expected loan payment, get pre-qualified for a new loan and use that rate as a guideline to determine your expected monthly payment. You can use an online calculator to estimate your loan payment. Your dealership or lender can also help you estimate how much your monthly payment will be.
Are you going to be paying more or less than you are now? If so, how much more or less, and where will the money come from? Having answers to these questions helps you avoid financial mistakes when refinancing a loan.
3. Know the value of your car and your loan balance
Cars experience fast depreciation, especially when bought new. A new car can easily lose up to 20% of its original value in the first year and 15% yearly for the following four years.
If you bought a new car a few years back, your car is probably not worth as much as you think it is worth. By year 5, your vehicle will most likely be worth 50% to 60% of its original value. You must know if you will save or lose money during your refinance process. You should refinance your car only if the vehicle has a higher loan balance. Refinancing a car loan for a car that has almost paid off will only cost you money.
Use online car value estimators to find out your car’s current value. Kelly Blue Book is one of the most trusted sites for estimating car values. The value of the car and the current loan balance will help you decide whether to refinance it.
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4. Check your credit score
Before your new lender assumes responsibility for your loan and takes the risk, the lender will evaluate your payment activities, credit score, and credit history.
What the lender wants is a borrower who poses less risk. So, to qualify for a competitive interest rate on a new car loan, you must have a good credit score. Although some lenders will accept scores in the 600s, it is a good idea to refinance a car loan when you have a credit score of 720 or higher. This score puts you in the category of Super-prime borrowers and, therefore, helps you qualify for the lowest interest rate possible.
If you plan to refinance a car loan, check your payment activities and avoid missing any payments. Focus on what the lender wants. The more you build your credit, clean up your credit reports, and pay your bills on time, the better.
You might also like to learn how to get an 800 credit score.
5. Shop around for better rates
Not every lender will approve you for the same refinance rates. Lenders consider different factors when evaluating your creditworthiness and the interest you pay. What one lender considers essential might not be that important for another lender.
That is why you need to get multiple quotes from different lenders. Your current lender might offer you discounts if your past performance aligns with the terms of your car loan. So, start from there. Getting pre-qualified by other lenders, such as banks, credit unions, and online lending institutions, can help you get the most out of the new loan. One thing to keep in mind is that some lenders will pull your credit report to give you an accurate estimation.
Requesting to view your credit profile will result in a hard inquiry on your credit reports and lower your score by 5-10 points. So, unless you have decided to go with that specific lender, you should try to get an estimate without pulling your credit reports.
Once you have been pre-approved by multiple lenders, choose the loan that offers better rates and favorable terms. Refinancing your loan will benefit you only if it saves money or makes it affordable.
6. Choose the lender with the lowest interest rate
Since each lender will qualify you for a different internet rate, fee, and terms, use these factors to compare lenders and stick with the one that will save you more money. You also need to compare your savings with how much your current loan will cost you. If your savings are significant and you get better terms, refinance the car.
7. Get ready to refinance your car loan
After choosing the lender, you must prepare to refinance your auto loan by gathering all needed documentation and information. The following is the information you need to refinance a car loan.
- The lender will want to know your full identity. So, you must have proof of identity, full name, address, email address, phone number, social security number, etc.
- The lender will also need details of your current loans. So, you need to provide proof of payment, proof of remaining balances, etc.
- Having an income shows that you can afford your monthly payments. So, you will need to provide proof of income. Lenders usually require paystubs, the name of the employer, and the address.
- Finally, your new lender must also register your car information. So, be prepared to provide your car’s model, make, year, and color. You might also need proof of auto insurance and the car’s title.
After refinancing your loan, any payment you make will go to your new lender. The terms of your new loan and monthly payments will also change.
When does it make sense to refinance your car loan?
Even if you qualify for the refinance, you must evaluate your options and refinance your car loan only when it makes sense. Before you refinance a car loan, wait at least one year to catch up on fast depreciation on the car. Waiting a little longer will also help you build enough payment history and help you recover from the impact of the first car loan on your credit profile.
It will also make sense to refinance your car loan when the new loan will result in a much lower interest rate. A lower interest rate will come with much lower monthly payments, enabling you to pay off the loan much faster. You should also refinance your loan when you are not too far behind with your current loan payments.
Finally, you need to evaluate the cost of the refinance and the benefits you are getting. Refinancing makes sense only when it saves money or gets favorable terms. Besides your closing costs on the new loan, your existing lender could also have loan termination fees. So, evaluate these fees and compare them with your savings.
Does refinancing a car loan lower my credit score?
Refinancing a car loan involves applying for a brand-new loan. The lender will pull your credit file before you get approved for the refinancing, resulting in a hard inquiry on your credit reports. Each hard inquiry lowers your credit score by 5-10 points. Car loan refinances might also reduce the average age of your credit, which might lower your credit score.
Where to refinance a car loan?
When refinancing your auto loan, you should always aim for lower interest and better terms. If you are unhappy with your current lender, shopping for a more affordable car loan might be a good idea.
You don’t have to stick to your current dealership or lender for the refinancing option. There are other lenders out there who are ready to work with you regardless of your financial situation. Banks, credit unions, and online lending institutions can work with you. But, starting from there is a good idea if you have a bank you work with. The history you have built with your current bank can help you qualify for better terms.
Tips to qualify for a low interest rate on a car loan
The interest rate is one of the main factors to evaluate when refinancing your car loan. Lower rates lower your monthly payments, reduce the cost of the car, and make it affordable to pay off the car. You must meet certain criteria to qualify for the lowest interest rate when refinancing a car loan.
You first need to answer the following question. What does the lender want?
The answer to this question will boil down to risk assessment. Every lender wants to do business with borrowers with the least risk possible. The lesser your risk as a borrower, the more lenders will trust you with their money. More trust leads to giving you the lowest rate possible with better terms. That is why creditworthiness matters the most when taking out loans.
Lenders categorize borrowers into groups based on their credit scores, as detailed below, to assess their creditworthiness.
Risk profiles of borrowers based on credit scores
As your credit score decreases, the risk of lending you money increases. For this reason, lenders will charge you a higher interest rate to balance that risk. According to the Consumer Financial Protection Bureau, the following are borrowers’ risk profiles based on credit scores.
- Super-prime (credit score of 720 or higher). A borrower in this category carries the lowest risks possible and qualifies for the best interest rate when borrowing money.
- Prime(credit scores of 660-719). Borrowers in this category pay a slightly higher interest rate because they carry more risk than Superprime borrowers.
- Near-prime(credit scores of 620-659). This is the lowest credit score range to qualify for most loans. For example, you need a credit score of at least 620 to qualify for conventional mortgages. Most car loan providers lend money to borrowers in this category or better. A credit score below this level will get you denied an auto loan.
- Subprime (credit scores of 580-619). Most lenders will deny you credit. Some lenders might accept your car loan application, but you will pay a much higher interest rate. Being in this category means that you carry more risks.
- Deep subprime (credit scores below 580). If your credit score is in this category, you will be denied credit from every corner of the lending industry. Yes, there are risky-takers out there. But, if you qualify for a car loan or auto refinance, you’ll pay the highest interest rate possible. The terms of your loan will also be strict. This is because borrowers in this category pose more risk than any other category. Deep subprime borrowers usually have bad credit and are more likely to default than other borrowers.
You might also like to know how to get the best car loan rates.
So, how do you qualify for a lower interest on a car loan?
To qualify for a lower interest rate, you must be a super-prime borrower with a credit score of at least 720. Lenders offer the lowest interest rate to their super-prime borrowers because they pose the lowest risks. Super-prime borrowers pay their bills on time, respect the terms of their loans, and are less likely to default. For this reason, they are rewarded with the lowest interest rate and favorable terms. If you want to refinance your car loan, raise your credit score before applying.
If you cannot be in the Super-prime category, at least be a Prime borrower. You will still pay a slightly higher interest rate. However, the terms of your loan might be favorable if you check other boxes, such as having a lower debt-to-income (DTI) ratio, a stable income, a track record of on-time payment, and a well-established credit history.
Is buying a brand-new car with a car loan is a good idea?
Buying a new car is never a good idea. But financing your car purchase with a car loan, especially a new one, is much worse. This is because the risks involved with owning brand-new cars outweigh their benefits. Here is what to expect when you purchase a car with a loan.
- You pay unnecessary interest. When you purchase a car with a car loan, you pay interest and many fees. These extra costs increase the cost of the car and make your monthly payments unaffordable.
- Your car loses value fast. A new car can lose up to 20% of its original value within the first year and up to 15% each year for the following 4 years. In other words, a new car will lose 40% to 60% of its original value in just 5 years. This depreciation does not justify the reasoning behind buying a new car in the first place.
- More money out of your pocket. Brand-new cars cost more, so you borrow more money without a sizeable down payment. The higher your principal amount, the more interest charges you pay.
- Expensive insurance. New cars come with expensive insurance. You must also purchase full coverage on a vehicle you bought with a loan.
If you have some savings, consider purchasing a used car with cash, as these are sold at a massive discount after depreciation. This strategy will prevent you from taking out expensive car loans. You will also have complete control of the vehicle. That is, you will pay no monthly payments, no extra fees, no charges, and, more importantly, no lien on the car. Since used cars are cheaper, your insurance will be more affordable. You can also get liability insurance in case your car has less value.
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Used car vs. new car: Which one should you buy?
Financially speaking, a used car is always the best option. When you compare the benefits you get from buying a used car vs. a new car, used cars stand out. New cars have many updated features, run better, look better, etc. But you also pay more for these updates.
The following are side-by-side comparisons of buying a used car vs. a new car.
| Features | Used car | New car |
| Down payment | Lower down payment | Higher down payment |
| Cost | Cheaper | Expensive |
| Insurance | Higher insurance. You can have liability insurance if the car is old | Expensive. You will need full coverage whether you purchase with a loan or not because you have more to lose. Lenders require full coverage. |
| Depreciation | Low depreciation rate | Fast depreciation. Can lose 40% to 60% of their value in just 5 years |
| Fees | Lower fees | You pay a lot of fees |
| Affordability | Affordable for both loans or paying with cash | Not affordable. It is also hard to pay to purchase new cars with cash because they cost more. |
| Maintenance | Can cost you more in maintenance, especially in much older models | Less likely to break down and run better |
| Features and gadgets | Older safety features and outdated gadgets | Updated safety features and gadgets |
You should try to buy a car that has depreciated. A 4-5-year car can offer similar benefits to what you get when you buy a new car. Instead of paying the full price for a new car, you will purchase them at a 40% or more discount. These cars also run and look like new ones.
The bottom line
Refinancing your car loan could be a good financial decision if you don’t like your current lender due to higher interest rates or less favorable terms. However, before you refinance a car loan, you must evaluate whether you qualify for a loan refinance and if this is an excellent financial decision. Ensure that the cost of refinancing an auto loan is less than what you will benefit from the refinance.
A good credit score will help you qualify for a lower interest on the new loan, showing that you pay your bills on time and use debt responsibly. You should also shop around and get quotes from multiple lenders for the lowest interest and favorable terms.
