Refinancing is a smart way to spend less on your car over time. If you’re paying a high interest rate, it might help. Many refinance to get a lower rate, reduce their monthly bills, or change their loan terms. Today, let’s learn what refinancing means and how it works, so you can decide if it’s right for you.
What Car Loan Refinancing Means
Refinancing is getting a new auto loan to pay off and replace your current one. Once it is approved, the lender sends the funds to your current creditor and pays off your old loan. From then on, you pay the new lender instead, but you still have the same car.
The goal is usually to secure better loan terms that benefit you. For example, if your original loan had a 10% interest rate and you refinance into a loan with a 5% rate, you’ll pay much less interest in total. Refinancing allows you to “redo” your car loan under more favorable terms.
The new lender will usually become the lienholder on your car title, replacing the old one. This process is mostly handled behind the scenes. You may need to sign a few documents and update your insurance with the new lender’s information, but you won’t need to visit a dealership or make any changes to the car.
Reasons People Refinance Auto Loans
There are several common reasons why car owners choose to refinance their auto loans:
Lower Interest Rate
The most popular reason to refinance is to lock in a lower interest rate on your loan. Interest is the extra amount you pay a lender for borrowing money, so a lower rate means you pay less.
Smaller Monthly Payments
Another big reason is to reduce the size of your monthly car payment. This can happen if you get a lower interest rate, extend the loan term, or both. Extending your loan term will make monthly payments smaller, but you might pay more total interest by taking longer to pay off the loan.
Shorter Loan Term
Some borrowers refinance to shorten the loan term. If your financial situation has changed for the better and you can afford a higher monthly payment, refinancing into a shorter term lets you pay off the car faster. It is useful if your goal is to eliminate the car loan debt quickly.
Removing or Adding a Co-Signer
Refinancing is also a way to change who is on the loan. If you originally needed a co-signer to get approved, you might later refinance solely in your name once you qualify. On the other hand, if you’re struggling to get a good rate, you could add a co-signer with strong credit.
Switching Rate Type or Lender
Some people have variable-rate loans. If your rate can change with the market, you might refinance into a fixed-rate loan for more stability. Even if your current loan is fixed, you might refinance to switch to a lender that offers better customer service.
Tapping Equity
A less common reason is to tap into your car’s equity. If you owe much less than the car is worth, some lenders allow “cash-out” auto refinancing. It means you refinance for more than you owe and take the extra cash out for other needs.
What You Need Before You Apply
Before applying to refinance, gather some information and paperwork:
Details of your current loan. Know your loan payoff amount, interest rate, monthly payment, and how many months are left. You can find most of this on your latest loan statement or by contacting your lender.
Information about your car: Be ready to provide details about your vehicle, such as the make, model, year, and mileage. You’ll also need the Vehicle Identification Number (VIN), a unique 17-digit ID for your car. Lenders use this information to determine its current value.
Personal and financial documents: You must prove your identity and repayability. You should have:
- A valid driver’s license or other photo ID.
- Proof of income, such as recent pay stubs or tax returns.
- Proof of residence.
- Proof of car insurance.
Also, have your Social Security number handy, because the lender will use it to run a credit check. It’s a good idea to check your credit report and score before applying, so you know where you stand. You can get a free credit report yearly from each bureau.
Steps to Refinance a Car Loan
Refinancing your car loan is a straightforward process with several steps:
- Review your current loan and finances. Look closely at your existing auto loan and overall financial picture. Note your current interest rate, monthly payment, remaining balance, and time left on the loan. Consider your credit score and any changes in your income or expenses since you got the loan.
- Check your credit score. Your credit score plays a big role in the refinance offers you’ll qualify for. The higher your score, the lower the interest rate you can get. If your score has improved since you took the original loan, you can refinance at a better rate.
- Shop around for offers. Compare rates and terms from multiple lenders, such as banks, credit unions, and online auto loan companies. You can often get pre-qualification quotes online with a soft credit check.
- Apply for the new loan. Once you’ve identified a lender and a quote you like, submit a formal application. It can often be done online or at a bank branch. You’ll provide personal information, details about your car, details about your current loan, and income information.
- Get approved. Once you submit your application, the lender reviews it. Many will decide fast, often within the same day. If they approve you, they’ll outline the terms of your new loan.
- Finalize the refinance. If you’re happy with the terms and officially accept the loan offer, the lender will close the loan. You’ll have some documents to sign to seal the deal. The new lender will then pay off your old car loan directly.
How Refinancing Affects Your Credit
It’s wise to consider how refinancing your car loan might impact your credit score:
Hard Inquiry On Your Credit Report
When you apply for any loan, the lender will perform a hard credit inquiry to check your credit history. It causes a slight dip in your credit score, such as by a few points. If you submit multiple auto loan applications within a short window, those inquiries count as just one for scoring purposes. It’s about 14 days for most FICO scores, and up to 45 days for some newer scoring models like VantageScore. You can shop around without greatly hurting your score.
New Credit Account And Closing the Old Loan
Refinancing replaces one loan with another on your credit report. Your old auto loan will eventually be closed, and a new loan will open. This can affect the average age of your accounts and your credit mix. The average age of accounts might drop slightly since you’re adding a new account, which can have a minor negative impact. However, installment loans are part of a healthy credit mix.
Impact of On-Time Payments
The best thing you can do for your credit is to make all payments on time. Payment history is the biggest factor in your credit score. If refinancing gets you a more affordable payment, it may help your credit. Your score may improve if the refinance makes it easier for you to pay down the loan.
Final Thought
Refinancing your car loan can be a valuable move to save money or make your payments more manageable. Remember to check your financial situation and goals. Once you are clear on that, shop around and compare offers from lenders to find the most favorable terms. If a refinance can improve your financial picture, it’s worth considering.