The Rules of Car Loan Refinancing
Access to a car is pretty much a necessity and a freedom that most Americans wouldn’t want to do without—even if car loan payments take a big bite out of their budget. In a 2018 survey conducted by the National Endowment for Financial Education, 15 percent of U.S. adults said they worried about their car loan debt. Whether or not you agree that owning your car is a financial burden, bringing monthly costs down is a good goal to have.
So the big question: When is it a good time to refinance your car loan? How about when you need monthly payments to be more manageable. That’s a good answer. But there are a few other things to consider. But first you should get a good understanding of how refinancing a car works so the route you choose meets your specific goals.
How does refinancing a car work?
Refinancing your car is a lot like refinancing your house; you’re getting a new car loan to replace the one you have. Here are the factors to consider to do that successfully:
- Make sure your credit is strong. Get your credit report, which is free once a year, and check for mistakes that may lower your credit score. If there are any, get them fixed. Look for items you can pay down or off, especially anything in collections. Check your credit score, which is what most lenders use to determine how likely you are to repay your debts. It’s based on the information on your credit report like payment history, credit history length, debt levels, types of credit history. You can get your credit score free from Discover once a month.
- Estimate your car’s loan-to-value (LTV) ratio. Unlike homes that can appreciate in value, cars depreciate in value over time. But like a house, you’ll need equity in your car to refinance. To start, you’ll need to determine your auto’s value and whether you’re “upside down” in your loan—meaning what you owe is more than the car’s actual worth. You can research your car’s current value on sites like Kelly Blue Book or NADA Blue Book before beginning the refinancing process.
- Shop around for the best loans. Finding the best loan is essential so you get the interest rates and repayment terms that work for you. You can do this easily online by using your favorite search engine to compare offers. By not doing your research, you could overpay for your loan. Look for the shortest loan term at the highest monthly payment you can swing. Remember, like home refinancing, your refinanced auto loan restarts the clock on your loan. Read the fine print on every offer to make sure it’s right for you.
- Get your paperwork together. Besides proving your identity, lenders want to know you can pay your new auto loan back. So know what documents lenders want for the car loan refinancing process and set them aside. To be sure you have everything you need, contact lenders you’re considering and ask them what paperwork they require.
When is it a good time to refinance your car loan?
It’s most ideal to refinance your car loan when one of these three situations occur:
1. When your credit score has improved: Improvement in your credit score since you purchased your vehicle may mean it’s time to refinance. The higher your credit score, generally, the lower your interest rate for your auto loan and the better terms you’ll get for your car refinancing.
You could get a lower interest rate and have more of your monthly payment going to principal and not interest if you do. Over the life of your loan, refinancing to a lower interest rate may save you hundreds or thousands of dollars in payments.
Use a car refinance calculator to determine how much you could save over your car loan’s new term if you refinance.
2. When you need to reduce your monthly payments: If the amount of your monthly auto payment feels burdensome, you might reduce it by refinancing. When you refinance, you may be able to extend your repayment term, which may lead to lower monthly payments.
That could mean more income to put toward other monthly expenses. Run your numbers with a car refinance calculator to see how much monthly savings you’ll see.
Even if those numbers look good, make sure you’re not refinancing into a loan with a higher interest rate or less favorable repayment terms and conditions. Research the process and true costs of refinancing carefully.
When you think you’ve found the right loan, ask clarifying questions of your lender about how refinancing a car works until you’re sure you understand your new loan before accepting.
3. When interest rates drop: If you finance your vehicle through your dealer, you may not have received the best interest rate. Start looking for better deals, identify one and refinance your car loan—especially if you see interest rates dropping. The best place to look may be a financial institution where you already have a relationship. If they don’t offer auto refinancing at all or at lower rates than what you already have, your next best bet may be your local credit union. Credit unions usually offer lower cost loans even if you have a low credit score. If you’re not a member of a credit union, you would need to join to get the best rates. But the cost of membership is usually low and the process worthwhile if you can get a good deal by becoming a member.
Can you refinance your car too soon—or too late?
Many people think it’s necessary to wait a set number of weeks or months to consider refinancing. Others wait too long to refinance their cars for it to make financial sense. Here’s what to know about refinancing timing.
- You can refinance as soon as you buy your car. If your credit score is high enough and your financial picture strong enough to get better than your dealer-arranged financing, you can pursue refinancing. In some states, you need tag and title in place before you can start the process. But, in most cases, you don’t have to wait beyond that. It’s important you make payments until you get refinancing in place, however. Don’t assume starting the process and getting a firm offer of refinancing means it’s okay to delay payments. You may decide you don’t like the new loan terms at the last moment or you want to shop around more. You don’t want to jeopardize your credit or put yourself at risk of repossession by not making current payments on time.
- Don’t wait too long to pursue refinancing. There are typically only two times it’s too late to refinance your car. The first is when you’re near the end of your loan term. If you have paid on your car for three years, do you really want to start a new loan term of five to seven years when there are only two years left on your current car loan? The only exception is if you’re refinancing a vehicle you leased because the lease term is ending, and you want to keep the car. Be certain you won’t end up paying more for the vehicle than it’s worth by extending loan repayment terms for those additional years. If you really must lower your car payment late in your loan term for financial reasons, it’s best to trade your current vehicle in for a less expensive one. The other time it’s too late to refinance your car loan is when you’ve had the car for so long it’s lost significant value and you’ll be upside down in your new car loan and your new loan is higher than the value of your car. That’s what you don’t want.