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. 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 for doing that successfully.

1. 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.

In addition to getting your credit report, remember to check your credit score. This number is what most lenders use to determine how likely you are to repay your debts. Your credit score is based on the information on your credit report like payment history, credit history length, debt levels, and type of credit history.

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 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.

3. 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.

4. Get your paperwork together.

Besides proving your identity, lenders want to know you can pay your new auto loan back. 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.

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.