What does it mean to refinance a car and how does it work?
When you refinance a car loan, it means you pay down your existing loan with a new auto loan—usually from a different lender. You’ll make payments to the new lender until your loan is paid off, and the new lender’s name will appear on your car’s title. While refinancing won’t lower your total loan amount, you may benefit from more favorable terms.[1]
For example, if your new car loan has a lower interest rate, your new loan will accrue less interest each month. Even if you do not qualify for a lower interest rate, you could still lower your monthly payment by extending the length of your loan term. This strategy could be helpful if your finances have changed and you need some extra wiggle room in your monthly budget.
Alternatively, if you can afford a higher monthly payment, choosing a loan with a shorter term might help you score a lower interest rate.
When could auto loan refinancing be a good idea?
It’s important to consider timing when refinancing your existing car loan. Here are a few situations when auto loan refinancing often makes sense.
- Your financial situation has improved. You may want to shop for auto loan refinancing if your income or credit score have increased since you first took out your auto loan, or if you’ve paid off debts and have a lower debt-to-income (DTI) ratio. The changes could help you score a lower interest rate or more favorable loan terms if you refinance.[1]
- Market interest rates have dropped. Even if your personal situation hasn’t improved, market competition impacts auto loan rates. When interest rates fall, lenders may offer lower rates to attract new customers. Check rates with multiple lenders to see if you might benefit.
- You didn’t shop around for your first loan. Dealerships can markup rates which may may result in higher interest rates and longer loan terms.[2] If you originally financed your auto loan through a dealership, you may qualify for better loan terms through a bank or lender. In some cases, the terms may still be better even if your financial situation or market interest rates haven’t changed.
- You want to lower your monthly payment. Sometimes lowering your monthly payments takes priority over getting a lower interest rate. If you need to free up room in your monthly budget, refinancing your auto loan could help you get a longer term and lower monthly payment.
When could refinancing your car loan not be a good idea?
Sometimes it’s better to wait before refinancing your auto loan. Here’s a closer look at times when you should hold off.
- You can’t get a lower interest rate. If market interest rates have gone up or your financial situation hasn’t changed, it may make sense to hold off on refinancing.
- You’re upside down on your car loan. When you owe more on your vehicle than it’s worth, most lenders won’t allow you to refinance.[4]
- You don’t meet lender requirements. Many lenders won’t offer refinancing until you’re at least a few months into your current loan. On the flip side, some lenders require a longer period remaining on the loan term. If you’re near the beginning or end of the term, you may not qualify.
- You don’t want to pay fees. Some lenders charge origination fees when you take out a new loan. In some cases, the amount is calculated as a percentage of the new loan amount and then deducted when the loan is funded. Your current loan may also charge you a prepayment penalty for paying off the loan early, often calculated as a percentage of the remaining loan amount.[3]
- You don’t want your credit affected. Many lenders, like LendingClub Bank, let you check your rate without affecting your credit score by conducting a soft credit inquiry. However, once you apply, the lenders usually perform a hard credit check, which could cause your score to take a temporary dip.