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Refinancing your auto loan is when you replace your current loan with a new one with different terms. Refinancing can be a great way to save money on your car loan if you score a lower interest rate.
On the other hand, refinancing a car loan doesn't always make sense, and may depend on your car, the market and when you refinance. Before proceeding, it's a good idea to determine when a refinance might benefit you the most. Here's when it's a good time to refinance.
What Is Auto Refinancing?
Auto refinancing is when you take out a new car loan to replace your current one, usually with the goal of securing a lower interest rate to save money over your loan term.
Refinancing into a shorter loan term could also help you save on the total amount of interest you pay. The tradeoff here is that you'll accelerate your payoff timeline, albeit with higher monthly payments. Or, you could refinance into a longer-term car loan to lower your monthly payments, but this could cost you more in interest in the long run.
When Should You Refinance Your Car?
Refinancing your auto loan can be a good option to save money in some scenarios, such as:
When Your Credit Score Improves
If your credit score is higher than when you took out your current loan, you may be able to snag a lower interest rate on a refinance loan. Similarly, a lower debt-to-income ratio might also lead to a reduced rate. Consider your credit score to help decide the best time to apply for a refinance. For example, if you just paid off a couple of credit cards, it could take a few months before the payoffs positively impact your credit score, so consider waiting before applying.
When Interest Rates Go Down
Experian's Q1 2024 State of the Automotive Finance Market Report noted that used car loan rates, which tend to move in line with refinance rates, ticked up about 0.5% to start the year. It may not be the best time to refinance if today's rates are higher than your current loan's. Hold off on refinancing if the current refinance rate is more than what you pay now. However, if rates start to drop, it might be an opportunity to lock in lower interest rates on a car refinance.
When You Fall Behind on Payments
If you're struggling to make your monthly payments and don't want to lose your car to repossession, reducing your car payment could give you the breathing room you need. Even if you don't qualify for a lower interest rate, you might get a lower monthly payment by applying for a refinance loan with a longer term.
When Your Car Has Equity
Equity is the amount of your car's value minus your remaining loan balance. So, if your car is worth $18,000 and your loan balance is $12,000, your loan-to-value ratio is 66%, and you have 33% equity in the vehicle.
Lenders consider refinancing a safer investment if you have positive equity in your car than if you don't. If you default on the loan, the lender could make more money reselling your vehicle if you have more equity. Given this assurance, the lender may extend you a more favorable interest rate since it's taking on less risk.
When Not to Refinance Your Car
Refinancing your car isn't always a good idea. Here are some situations when a refinance might not benefit you.
When Your Loan Has a Prepayment Penalty
You may incur a prepayment penalty—up to 2% of your loan balance—if you pay off your loan in full before it's due. While this fee isn't common among major car lenders, it does exist. If your loan documents include a prepayment penalty, refinancing may not make sense if the savings from refinancing doesn't exceed the cost of the penalty.
When Your Loan Is Underwater
If you owe more than the value of the vehicle, you can still refinance your car, although it may not be the best idea. That's because your original lender will require you to pay the difference (called negative equity) as a lump sum before considering the matter closed. If you don't have enough cash to pay the negative equity, you'll have a difficult time making it work.
When You Want to Extend the Loan Term
While this strategy can be helpful if the alternative is defaulting on the loan and losing your car, it's generally not a good idea if you can afford the payments you currently have. If you replace your current loan with one that has a longer repayment term, you'll pay more in interest over the life of the new loan—unless you can manage to pay it off early.
When You Don't Want to Impact Your Credit
It's generally not a good idea to refinance if you're also looking to take out another loan, such as a mortgage. Remember, every time you apply for a loan, the lender will run a hard inquiry on your credit report. This inquiry generally reduces your credit score by five points or less, and its effect on your credit is temporary.
Opening a new credit account could also affect your credit scores because it reduces the average age of your accounts—a factor that makes up 15% of your credit score.
In both cases, the potential negative impact on your credit is typically minimal and temporary. If you start missing payments on your new loan, however, it could have a bigger and longer-lasting impact on your scores.
How Soon Can You Refinance Your Car?
You may want to refinance your car soon after driving it off the lot. While there are no industry-wide rules against refinancing right away, some lenders may require you to wait at least six months before refinancing. Still, plenty of lenders don't have such requirements, meaning you can refinance as soon as it's advantageous for you.
Keep in mind, it may take 60 to 90 days for the car title to transfer to your lender. Also, your credit score could temporarily drop slightly from the hard inquiry when you apply for your loan. A few months of waiting time, or longer, may give your credit score time to rebound. Improving your score could also help you qualify with more lenders.
It's worth noting that it is possible to wait too long before refinancing. Some auto refinance loans have maximum age and mileage requirements and may also require at least two years remaining on the loan. Also, the remaining loan term may be too short to save enough on interest to make refinancing worth your while.
How Much Money Can You Save by Refinancing?
Refinancing your car loan could save you hundreds or even thousands of dollars, depending on how much you can lower your interest rate. Similarly, you could also save money by shortening your loan term. In this case, you'd make higher loan payments, but it could reduce the total amount of interest you pay.
Using a car payment calculator, you can determine how much money you might save by refinancing your auto loan. Suppose you have a five-year $30,000 car loan at 8% interest. That's the approximate average rate at which 60-month new car loans have remained since 2023. In this example, you'd make monthly payments of $608 and pay around $6,498 in total interest.
A year into your loan, you've paid down your principal by $5,083 with another $2,216 going toward interest charges. You now owe $24,917 on your principal balance.
Then, interest rates drop or your credit improves, and you secure a low 6% rate from a bank or credit union to pay off the remaining $24,917 on your loan. You keep the loan term at four years. In this case, your monthly payment would drop to $585. On top of that, your interest charges would amount to $3,171 on the refinanced loan, $1,110 less than if you kept your original loan, saving you nearly 26%.
Of course, possible loan fees may come into play as well, so ensure that any fees don't cut into your savings too much.
How Do I Refinance My Car?
If you decide to refinance your car, take the following steps to complete the process:
- Check your credit. Credit score requirements vary by lender, but you may qualify for a car loan with a 600 or higher credit score. Of course, higher scores will improve your approval odds and may help you secure a lower rate. Consider waiting a few months before applying if you need time to improve your credit. You can check your credit from all three credit bureaus for free at AnnualCreditReport.com or check your Experian credit report and score for free anytime.
- Collect your supporting documents. Gathering important documents ahead of time can help the application process go more smoothly and potentially prevent delays. Before applying, round up the following documents to support the information you'll enter on your application:
- Driver's license or government-issued identification
- Social Security number
- Car registration
- Proof of insurance
- Proof of residence
- Proof of income
- Shop multiple lenders and compare offers. Comparing offers from several lenders can help you find the best combination of rates and terms. Many lenders let you prequalify without impacting your credit before submitting a formal application. Finding the lowest rate possible is important, but also compare repayment terms and fees to identify the best loan for your needs.
- Apply for a new car loan. Once you've narrowed your choices to one lender, submit your application online or in person at a local office. Your loan could be approved the same day you apply, or a decision could take several days. Funding could also take one to three business days.
- Review the loan terms and sign. Once you receive the final loan documents, review them carefully to make sure the rate and terms you agreed to are included in the contract. If you understand and agree with the terms and conditions, sign the new auto loan.
The Bottom Line
You might consider refinancing your auto loan if you can secure a lower interest rate that reduces the total amount you pay in interest over time. Plug in the numbers of any loan you're considering into Experian's auto loan calculator to determine how much money you might save.
Of course, the best rates on car loans are typically reserved for applicants with higher credit scores. Take steps to improve your credit score fast before applying. Consider enrolling in free credit monitoring to track your progress and avoid surprises when you apply for a new loan.