Refinancing an auto loan involves replacing your old auto loan with a new one to get a lower interest rate or shorter loan term. It’s often used to manage debts more quickly and efficiently and, in some cases, even save money. To successfully manage your auto loan, it’s crucial that you understand what auto loan refinancing is, how it works and how it could benefit you.
How Does Auto Loan Refinancing Work?
When you refinance an auto loan, you replace your existing loan with a new one to make payments more manageable or to tackle debt sooner. That said, when refinancing auto loans, it’s important to ensure you’re securing a lower interest rate, shorter terms or more affordable monthly payments. Two options to refinance auto loans include traditional and cash back refinancing.
Like most loan products, auto loan refinancing options come with eligibility requirements. Lenders will look at your creditworthiness and use that to determine your interest rate and terms. If your credit score hasn’t improved since you first took out your original loan, you might not qualify for more favorable loan terms. If you do qualify, you can look for options amongst different banks and online lenders.
It’s important to carefully consider your options before refinancing an auto loan. Changes in your interest rate can reduce your monthly payments, but if you opt for a longer term, you may end up paying more in interest. On the other hand, a shorter term with higher interest may mean larger monthly payments but less interest paid in the long term.
For instance, if you qualify for a 36-month term with a 2.5% interest rate and a 60-month term with a 2% interest rate for a $10,000 loan, you’d end up paying $48 more in interest with the latter.
Auto Loan Refinancing Options
Refinancing an auto loan comes in two basic forms: traditional and cash-out.
Traditional refinancing entails getting a new loan with a lower interest rate or better terms to pay off the old one. Cash-out — also referred to as “cash back” — refinancing includes borrowing against your vehicle's equity in exchange for a lump sum.
Both options suit different applicants. To avoid problems and maximize savings, borrowers should choose an auto refinancing solution that meets their needs and financial circumstances.
Traditional Auto Loan Refinance
Traditional auto loan refinancing involves taking out a new auto loan to pay off the remaining balance of your old one. It’s often done to secure better loan conditions, such as a lower interest rate, smaller monthly payment or a shorter or longer loan term.
If your credit score has improved since you first took out your auto loan, you’re likely the ideal candidate for auto loan refinancing. Most banks and online lenders offer this financial product to make debt more manageable, and if your credit score has improved, you’re likely to be offered better terms.
For instance, if you have a $20,000 auto loan with a 10% interest rate and a 60-month term, and your credit score has improved by at least 50 points, you may consider refinancing. If you have a remaining balance of $10,000 and qualify for the exact balance with a 60-month term and 8% interest, you’ll end up paying $582 less.
Cash Back Refinancing
Cash back refinancing allows you to refinance your loan and receive a lump sum of cash based on your car’s equity. For instance, if you only owe $10,000 left for your vehicle, but it appraises for $15,000, the extra $5,000 is your equity.
To get a cash back refinance loan, lenders will look at your credit score and have certain conditions for your car, especially since it secures your loan. For instance, you may be required to have a certain number of miles on your vehicle, or it must be no older than a threshold age.
Opting for cash back refinancing is an option you can consider if you want to get better conditions on your auto loan and need cash to pay for something else, such as a repair for your car or home. However, it’s essential to be wary of cash back refinancing since it increases your debt, while traditional refinancing only focuses on your existing balance.
When Should You Refinance Your Auto Loan?
Refinancing your auto loan can be a great idea — but only in certain situations. Understanding when auto loan refinancing can be helpful is key to ensuring you make informed decisions.
While refinancing your auto loan can come with benefits, it’s not always the best idea. Some circumstances where you should avoid refinancing include:
- Your credit score has worsened: Getting an auto loan with a low credit score may be challenging, as you may receive unfavorable terms, making monthly payments even more difficult to manage.
- You’re close to paying off your loan: If you only have a few months to a year left on your loan, you may not want to refinance as it might increase the interest paid.
- Interest rates have increased: If rates have increased since you took out your loan, you might want to hold off on refinancing until you can get more favorable terms.
- Your car is old: Lenders may have specific requirements to allow you to refinance your car, such as it being a certain age or having a certain mileage. If your vehicle is old, you may not qualify for refinancing.
Pros and Cons of Auto Loan Refinancing
Haphazardly refinancing your auto loan could lead to more debt, which can be challenging to manage if you’re looking for a reprieve. Thus, it’s crucial to carefully weigh the benefits and drawbacks of auto loan refinancing before making a decision.
How to Refinance an Auto Loan
If you’ve determined that auto loan refinancing suits your situation, knowing the steps to apply can help you prepare what you need ahead of time. Even though the application process varies from lender to lender, there are a few steps you’re likely to follow regardless of where you apply.
Prepare your personal information
Even if you’re refinancing an existing loan, your lender will still ask for your personal information, including but not limited to the following:
- Age
- Contact details (email, contact number, etc.)
- Social Security number
- Driver’s license
- Address
Gather employment and income documents
To prove that you can repay your new loan, lenders will ask for documents regarding your employment and income. Some information you might be asked for includes:
- Occupation
- Employment status
- Employer details
- Work contact details
- Proof of employment
- Recent pay stubs
- Statement on gross monthly income
- Details on your mortgage or monthly rent costs
These details give lenders an idea of what your income looks like and whether or not it’s stable.
Arrange your vehicle information
Lenders will want to know more about your current loan and the car you borrowed money for. Prepare to provide details on your:
- Current auto loan
- Most recent loan balance
- Remaining time on the loan
- Interest rate
- Vehicle identification number (VIN)
- Vehicle’s make, model and model year
- Current mileage
- Current vehicle registration
Review your credit history and score
Your lender will use your credit history and score to determine your loan’s new terms. It’s essential to look at your credit score ahead of time to get a rough idea of whether you’re likely to qualify for better rates. You can do so by requesting a copy of your credit report from one of the three credit bureaus, each of which often provides you with at least one free report a year.
Not only does this give you an idea about your rates, but it also prevents you from having your lender pull a credit report with mistakes. If you spot any errors on your report, you can dispute them before refinancing to ensure it doesn’t impact your offer.
Apply and compare multiple offers
Once you have all the necessary documents ready, opt to prequalify with several lenders. While they won’t tell you your official interest rate or terms, you can better compare who might give you the best offer based on this information.
Negotiate your refinance offer
After narrowing down your choices and applying, you can proceed with or negotiate the offer. If your credit is in a good place, you may be able to ask for a lower interest rate or a longer term.
Evaluate contracts and finalize the loan offer
If you are approved, you’ll receive a notice from your desired lender that includes the more specific details of your offer, such as what the final interest rate is, how long you need to repay it and more.
Alternatives to Auto Loan Refinancing
Beyond refinancing your auto loan, there are other alternatives you can opt for that may suit your situation better. Understanding all your options can help you choose the solution that can best help you manage your auto loan.
- Home Equity Line of Credit
Home equity lines of credit, or HELOCs, allow you to borrow against the equity in your home. HELOCs are a revolving line of credit, which means they act like a credit card — you pay interest only on the amounts you borrow, up to a limited amount depending on your equity. A HELOC is a good alternative to auto loan refinancing since you’re likely to get lower rates than standard loan options because it's a secured loan.
However, unlike credit cards, you can only draw on a HELOC for a specific period of time, depending on the lender. For instance, you can borrow money during a three- or five-year period before your repayment period kicks in, which can last anywhere from ten to thirty years. - Peer-to-Peer Loan
A peer-to-peer loan lets you borrow funds from multiple people, who receive a portion of the interest you pay depending on how much they contributed to it. It’s available on platforms like LendingTree or Prosper, where the site itself sets the rates and terms based on your creditworthiness and other details.
With a peer-to-peer loan, you can use the funds for more than just auto loan refinancing and borrow extra to pay for other necessary expenses. This is a good option if you have bad credit, as it might be easier to qualify for than a traditional loan. However, you’re still likely to get a better interest rate and loan terms if your credit is good. - Vehicle Trading
If you’re looking to refinance your auto loan because you can no longer meet your payment obligations, you might consider vehicle trading instead. This allows you to trade your car into a dealership and get the best possible price — ideally, one that can cover your remaining balance on the loan. If you get a little extra, you can even use that for the down payment on your next car.
However, vehicle trading can be tricky. Dealerships often want to offer the lowest possible price when you trade in your car, as this allows them to profit when they sell it off. - Selling Your Vehicle
If you want to get the highest possible price to repay your loan and get some extra, you may consider selling your car entirely. This removes the challenge of repaying an auto loan but also leaves you without a private vehicle. Selling your vehicle should only be considered if you are truly unable to repay your loan.
FAQs About Auto Loan Refinancing
Auto loan refinancing can make debt management easier — but only if it’s done wisely. Learn more about the ins and outs of refinancing your auto loan with our frequently asked questions.
Yes. Traditional auto loan refinancing lenders still base your interest rates and approval on your creditworthiness. If you have bad credit, you are unlikely to be approved.
If you don’t have good credit or have delinquencies in your credit history, you are unlikely to be approved by a lender to refinance your auto loan.
Generally, the sooner, the better. The closer you are to finishing off car payments, the less likely you are to save on interest — which is the main point of refinancing. Additionally, some lenders may require you to have a certain number of years left on your auto loan to refinance it.
It varies based on the lender. Some lenders may take a few days, while some lenders may take a few weeks to determine if your refinancing loan is approved.
It depends. If you qualify for a lower interest rate or opt for a longer term, your monthly payments will decrease. However, if you opt for a shorter term, your monthly payments will increase but may lead to less interest paid overall.
About Christopher Boston
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