Auto Loans

Here’s What to Know About Refinancing a Car Loan

To refinance a car loan, you replace your current debt with a new loan, typically with a different lender. Qualifying for a new loan usually requires showing a good credit history and being current on payments.

Your car will act as the collateral for your refinanced loan just like your current one. Here's how the process works and what to think about before you apply.

How Refinancing a Car Loan Works

When you refinance your car loan, you're effectively transferring the debt to a different lender, preferably through a loan that has better terms than what you have with your current lender, such as a lower interest rate.

The process of applying for a refinance loan is similar to what you did when you got your first loan. The difference is that you'll always work with lenders directly when refinancing instead of through a dealer, which sometimes happens when you first purchase a car.

Once you find a lender to refinance your car loan and get approved, the financial institution will directly pay off your existing loan and the original lender will transfer over the title to the new one.

How to Refinance Your Car Loan

The car refinancing process can vary a little from lender to lender. But in general, here are some steps you'll take from start to finish:

  1. Check your credit. Refinancing a car loan may not make sense if you don't qualify for better terms than what you already have. By checking your credit, you can see what your chances are of getting approved for a new loan and whether your credit has improved since you got the original loan.
  2. Confirm the existing loan details. Refinance lenders will typically want to know how much you currently have left on your loan. This is called the payoff amount, and you can request it from your current lender. You may also need to gather some information about your vehicle, including the vehicle identification number (VIN), year, make and model so prospective lenders can determine whether it's worth financing.
  3. Shop around. Take some time to research the best rates and the right offer that fits your financial profile and needs.
  4. Prepare for the loan application. You'll need to provide some documents to your new lender, and gathering them before you apply can make things go more smoothly. Requirements can vary by lender, but in general, you'll need proof of employment and income, proof of residence and proof of car insurance.
  5. Apply and evaluate the terms. Once you've found the right lender, submit an application and evaluate the terms it offers. The final offer isn't always the same as the initial quote, so you may need to apply with more than one lender if you don't get what you're expecting at first.
  6. Finalize and sign. Finalize your offer and sign the loan contract. You will need to provide your vehicle identification (VIN), your current lender details and any supporting documents requested.

What to Consider Before Refinancing a Car Loan

There are benefits and drawbacks to refinancing your existing car loan, and it's important to consider both when deciding what's best for you.

For starters, it's best to consider refinancing when doing so could help you score a lower interest rate, monthly payment or both. For this to happen, you typically need to have a better credit score than the first time around.

That said, refinancing may not be in your best interest if doing so extends your repayment term. While this can potentially lower your monthly payment, you'll end up paying more in interest over the life of your new loan.

Also, think twice about refinancing if there's a prepayment penalty on your current loan or you owe more than your car is worth.

If there's a prepayment penalty, it could neutralize any savings you realize from getting a lower interest rate. And if you're underwater on your current loan, you'll need to make a lump-sum payment for the difference between what you owe and the amount a refinance lender is willing to finance. Some lenders may not be willing to refinance that kind of loan at all.

Also, keep in mind that even if you want to refinance, it may not be possible. Some lenders, for instance, will not offer a refinance loan for vehicles that are older than five to eight years, depending on the make and model.

Each lender may have different limits on how old a car they will consider refinancing can be and may require that the payoff amount of your current auto loan fall between certain amounts to even be considered.

How Refinancing a Car Loan May Affect Your Credit

Applying for a refinance car loan can temporarily reduce your credit score because of the hard inquiry the new lender makes on your credit report. You'll typically see your score fall by just a handful of points, and with continuing positive payment history, you'll likely see it bounce back relatively quickly.

Don't worry about getting multiple hits when you shop around, though. As long as you submit your applications in a short period—typically 14 to 45 days—the credit scoring models will combine all of the hard inquiries into one when calculating your credit score.

Next Steps

Refinancing your car loan could potentially save you money each year and over the lifetime of your new loan. As you learn more about how the advantages and disadvantages of refinancing apply to your situation, take some time to consider whether it's the right step or if you should continue on with your current loan for the time being.

If your credit score isn't good enough yet to qualify you for better terms, work on improving your credit before you apply. It can take time, but the potential savings can be worth it.