Last updated: July 28, 2023

Market Insights

The rules of car loan refinancing: How does refinancing a car work?

Couple sitting on their couch discussing refinancing their car loan with a home equity loan

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 monthly budget.

Car loan refinancing is the process of taking out a new loan to pay off your existing car loan, and it is an opportunity for anyone looking to save money by lowering their monthly payments or reducing their loan term.

So, the big question: When is it a good time to refinance your car loan? Looking for lower monthly payments is a good reason to refinance, but there are a few other things you may want to consider. An understanding of how refinancing a car works may help you choose the best route to meet your financial goals.

Car loan refinancing: The basics

Refinancing your car is a lot like refinancing your house—you’re getting a new car loan to replace the one you have.

There are typically three primary reasons why people consider refinancing their car loans:

  1. Lower monthly payments: Refinancing at a lower interest rate or extending the loan term may reduce your monthly payments, making them more manageable within your budget.
  2. Save on interest payments: If you qualify for a lower interest rate, refinancing can save you money on interest payments over the length of time you’re paying it back.
  3. Change loan terms: Refinancing allows you to change the terms of your loan, such as shortening or extending the loan’s length, depending on your financial needs.

Here are the factors to consider for doing that successfully.

1. Make sure your credit is strong

Get your free credit report once a year and check for any inaccuracies or errors and follow the appropriate dispute process to get them corrected. Then look for any debts you can pay off, pay down, or consolidate—especially anything that’s in collections.

In addition to getting your credit report, remember to regularly check your credit score. Lenders may use this number to determine how likely you are to repay your debts. Your credit score is based on information from your credit report including payment history, credit history length, debt levels, and credit mix.

2. 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 that what you owe is more than the car’s actual worth. You may be able to research your car’s current value online before beginning the refinancing process.

3. Shop around for the best loans

The best loan available will typically be the one with interest rates and repayment terms that work for your budget. Compare multiple lenders and options available to you before applying. By not doing your research, you might overpay for your loan. Remember, like with home refinancing, your refinanced auto loan restarts the clock on your loan. You may be able to choose an option with a shorter term and a higher monthly payment but that comes with a lower interest rate—this could potentially save you money on interest charges over the life of the loan.

Whatever you decide to do, be sure to read the fine print on every offer to make sure it’s right for you.

4. Get your paperwork together

Besides asking for basic personal information to confirm your identity, lenders will want to assess whether you are able to pay your new auto loan back. Check out what documents lenders typically want for the car loan refinancing process and set them aside so you’re prepared when asked to provide them. To be sure you have everything you need, contact lenders you’re considering and ask them what paperwork they require.

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 finances are strong enough to get a better deal than your existing loan, you may 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.

However, keep in mind that it’s important you make payments until you get refinancing in place. Don’t automatically assume starting the process and getting an offer for refinancing mean you can delay payments. You may decide you don’t like the new loan terms at the last moment, or you want to shop around more. It’s a good idea to avoid jeopardizing your credit or putting yourself at risk of repossession by not making current payments on time.

When is the best time to refinance your car?

There are typically only two times when it’s too late to refinance your car. The first is when you’re near the end of your loan term. If you have made your car loan payments for three years, do you really want to start a new loan term of another 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. Just do some research beforehand and make sure 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 may be better 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 because your new loan is higher than the value of your car.

While these are two examples of when you may want to avoid a refinance, the ultimate decision about timing will come down to what works best for your unique situation. Knowing how to refinance your car the right way is the key to getting into a better loan. Do your research, be prepared, and use these tips to get the new deal you need.

Alternative loan options for car loan refinancing you may not have considered

Sometimes the best option for car loan refinancing may not be a car loan at all. For example, a home equity loan can be used to finance a car as well. Because this is a secured loan using the collateral in your home, the interest rate may likely be lower than a personal loan or dealer financing, but the term may be much longer than a traditional auto loan, so you may pay more interest.

While using a home equity loan may be a smart solution for some people when refinancing a car loan, it’s also worth considering a personal loan. As an unsecured loan option that doesn’t require collateral to borrow. These loans typically have fixed interest rates and repayment terms, which provides predictability in your monthly payments. However, the interest rates on personal loans may be higher than those that come with other forms of financing, particularly with loans secured by collateral.

The home equity loan advantage

Standard auto loan refinancing might be a great option for some—but using a home equity loan to refinance your car loan may come with additional benefits:

  • Lower interest rates: Home equity loans typically have lower interest rates than auto loans because they are secured by the borrower’s home. This means you could save even more on interest payments over the life of the loan.
  • Potential tax benefits: The interest paid on a home equity loan may be tax-deductible, unlike the interest paid on a traditional auto loan. This may result in tax savings for certain borrowers. Make sure to consult with a tax advisor to see if this might apply to your situation before moving forward with your home equity loan application.
  • Larger loan amounts: Home equity loans are based on the amount of equity you have in your home. If you have enough equity built up, it may allow you to receive a larger loan than you could with traditional auto refinancing.
  • Flexible repayment terms: Home equity loans may come with more flexible repayment terms than auto loans. This might help you tailor your monthly payments to better fit you financial situation.
  • Debt consolidation opportunities: If you have other high-interest debts, you can use a home equity loan to refinance your car loan and consolidate other debt into a single loan with a lower overall interest rate.

Is using a home equity loan right for you?

Like with any financial decision, there are several factors to consider before deciding whether using a home equity loan to refinance your car loan is the best option for you:

  • How much equity do you have in your home? To be eligible for a home equity loan, you need to have enough equity available in your home to borrow from.
  • Are you able to secure a lower interest rate? Always shop around and compare lenders, interest rates, loan terms, and fees before making a decision.
  • Can you comfortably make the new monthly payments? It’s important to ensure that using a home equity loan will result in an affordable monthly payment for your budget.

Closing thoughts: Refinance your car loan

Car loan refinancing may be a smart move to save money or adjust your loan terms to better fit your financial needs. While there are some alternatives to traditional auto loan refinancing that may be available to you, researching and comparing your options is essential.

Consider factors such as interest rates, repayment terms, fees, and your financial needs and goals. For example, utilizing a home equity loan for refinancing your auto loan may not only save you on interest payments but also provide other potential benefits or allow you to consolidate other debts as well. By weighing the pros and cons of your options and getting prepared with a clear understanding of your car’s value and your financial situation, you’ll be well on your way to finding the right way to refinance for you.

Discover® Home Loans offers home equity loans at low, fixed rates with flexible repayment terms. You can use a home equity loan to refinance your car loan, consolidate debts, make home improvements, or pay for other large expenses. Enter your details into our monthly payment calculator to get an idea of what your loan payment might look like. 

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