Refinancing a car loan can be a strategic move to lower your interest rate or monthly payments. However, this may be challenging if you have bad credit. Lenders often consider credit scores when evaluating refinancing applications since they're a key indicator of financial reliability.
That said, having bad credit doesn't automatically disqualify you. Understanding your options and the impact of your credit score can help you make informed decisions about refinancing your car loan.
Is It Possible To Refinance a Car Loan With Bad Credit?
Refinancing a car loan involves replacing your current car loan with a new one, typically with a different lender, to pay off the remaining balance on your existing loan. This is a solid option if you're struggling to make monthly payments or want to secure a lower interest rate.
When you apply for refinancing, lenders look at several factors to determine your eligibility. One of the most critical factors is your credit score. A higher credit score generally indicates that you're a lower risk to the lender, which can lead to more favorable loan terms, such as lower interest rates.
However, having bad credit doesn't necessarily mean you can't refinance your car loan. Some lenders accept borrowers with less-than-perfect credit. Shop around for options and find out their minimum credit score requirements to see which lender accepts your particular credit score.
What’s Considered a Bad Credit Score?
Credit scores usually range from 300 to 850. What’s considered a bad credit score may vary slightly based on the credit scoring model used. With FICO, anything under 580 is regarded as a bad credit score. Meanwhile, VantageScore considers credit scores between 500 and 600 as poor and scores between 300 and 499 as very poor.
You’re likely to hurt your credit score if you miss payments or have a high credit utilization ratio, which is the ratio of your credit card balances to their limits. Frequently applying for new credit can also impact your credit score, often leading to hard inquiries on your credit report.
Others Factors That Lenders Consider Beyond Credit Score
When evaluating a car loan refinancing application, lenders tend to consider other factors beyond just your credit score. These include your income, employment stability and the value of your vehicle.
- Income: Lenders want to see that you have a steady income and can afford to repay the loan. They'll typically ask for proof of income, such as pay stubs or tax returns.
- Employment stability: Having a stable job can make you more attractive to lenders. If you've been at your job for a long time, this can indicate to lenders that you have a reliable source of income.
- Debt-to-income ratio: This represents the portion of your income that goes towards your debts. Lenders typically prefer a debt-to-income ratio of 36% or less, including your proposed car loan payment.
- Value of the car: The vehicle serves as collateral for the loan, so its value is essential to lenders. If you owe more on your loan than the car is worth, this can make it more challenging to refinance.
- Amount owed: The amount you still owe on your current loan can also impact your ability to refinance. Lenders may be less likely to approve your application if you owe a lot more than the car is worth.
- Payment history: Even if you have a low credit score, a history of making your car loan payments on time can make you more attractive to lenders.
It's worth noting that each lender may weigh these factors differently, so it's a good idea to ask potential lenders about their specific criteria.
How To Refinance a Car Loan With Bad Credit
If you have bad credit, navigating the car loan refinancing process can seem daunting. But don’t be discouraged. By taking these important steps, you can increase your chances of successfully refinancing your car loan.
Review your credit report
Your credit report contains detailed information about your credit history, including your payment history, the amount of debt you have and the length of your credit history. Obtain your credit report from each of the three major credit bureaus — Experian, Equifax and TransUnion — and look for any errors or inaccuracies that could be hurting your score. If you find any, you can dispute them and have them corrected.
Shop for lenders
Shop for lenders: Lending companies have different criteria for refinancing car loans. Some aren’t willing to work with borrowers with bad credit, while others consider other factors beyond credit scores. These lenders may be more likely to refinance your car loan. Research various lenders to find those that are willing to work with borrowers with low credit scores. These include banks, credit unions and online lenders.
Once you've identified potential lenders, compare their loan terms. Look at the interest rates, loan terms and any fees associated with the loan. Even with bad credit, you should aim for the most favorable terms possible. As a rule of thumb, don't just accept your first offer.
Apply for refinancing
After choosing a lender, you'll need to apply for refinancing. Your chosen lender will likely perform a hard credit check, which can temporarily lower your credit score. They may also require documentation like proof of income, proof of insurance and information about your car, so gather these documents beforehand to expedite the review process.
Close on your new loan
Once your application is approved, the next step is to close on your new loan. This involves using the funds from your new loan to pay off your old one. After your original loan is paid off, you'll start making payments to your new lender under the terms of your new loan.
Risks of Refinancing a Car Loan With Bad Credit
Although possible, refinancing a car loan with bad credit can present several risks, including higher interest rates and fewer lenders. Understanding them can help you determine if this option is right for you.
- Higher interest rates: Lenders view borrowers with bad credit as riskier, which often results in higher interest rates. This means that even if you can refinance your car loan, you may end up with a higher interest rate than someone with a better credit score. Over time, this can significantly increase the total cost of your loan.
- Limited lender options: Not all lenders are willing to work with borrowers with bad credit. This can limit your options when it comes to finding a lender to refinance your car loan. You may need to spend more time researching and contacting different lenders to find one that will accept your credit score.
- Potential for longer loan terms: In some cases, lenders may extend the loan term to make the monthly payments more affordable for borrowers with bad credit. While this can lower your monthly payments, it also means you'll be in debt for a longer period of time and may end up paying more in interest over the life of the loan.
- Potential for negative equity: If your car's value has depreciated significantly, you might owe more on your loan than the car is worth. This is known as being "upside down" or "underwater" on your loan. Refinancing your loan can be more difficult if you're in this situation.
- Impact on credit score: Applying for a new loan involves a hard inquiry on your credit report, which can temporarily lower your credit score. If you're already dealing with bad credit, this can further reduce your score.
How To Improve Your Credit Score Before Refinancing
Improving your credit score before refinancing your car loan can increase your chances of securing better loan terms. Here are some tips to help you improve your credit:
- Pay bills on time: Your payment history is one of the most significant factors in your credit score. Make sure you're paying all your bills, not just your loans and credit cards, on time. Setting up automatic payments can help ensure you don't miss any.
- Pay down debt: The amount of debt you owe, particularly on revolving credit accounts like credit cards, also impacts your credit score. Try to pay down your balances and keep your credit utilization below 30%.
- Limit new credit applications: Each time you apply for credit, it results in a hard inquiry on your credit report, which can lower your score. Try to limit new credit applications, particularly in the months leading up to your refinancing application.
- Maintain a mix of credit types: Having a combination of different types of credit, including credit cards, mortgages and auto loans, can raise your credit score. However, this doesn't mean you should take on new debt just to diversify your credit mix.
Remember that improving your credit score takes time and consistently responsible credit behavior. Be patient and keep working towards your financial goals.
Frequently Asked Questions
MoneyGeek answered some frequently asked questions about refinancing a car loan with bad credit to help you arrive at a decision that makes the most sense financially.
About Christopher Boston
The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.
Editorial Disclosure: Opinions, reviews, analyses and recommendations are the author’s alone and have not been reviewed, endorsed or approved by any bank, lender or other entity. Learn more about our editorial policies and expert editorial team.