Auto Loan Refinancing: What It Is and How to Do It

Refinancing your auto loan means replacing your existing loan with a new one from a different lender. Your current loan gets paid off by the new lender and you start making monthly payments, hopefully smaller ones, on the new loan.

1. What is auto loan refinancing?

If you think your credit has improved since you bought, you should look into an auto loan refinance. There’s a good chance you can lower your interest rate and end up with a smaller monthly payment. You might also be able to shave some time off the loan, or go the other way and extend the term of the loan if you’re having trouble making your monthly payment.

What’s the catch? There really isn’t one — except it takes some time, and your credit profile might take a slight hit when you apply for the new loan. We’ll explain more about that later. However, know two important things:

Most auto loans don’t have a prepayment penalty, so refinancing won’t cost you anything.
Submitting an application for refinancing has no application fees and the funds become available quickly, often within a day.

2. Why you might want to refinance

Let’s say your current auto loan has a 10% interest rate and you’ve been making payments for a year or so. Chances are, your credit has improved and you could now qualify for a lower interest rate, which would lower your monthly payments. If you simply went to your current lender and asked it to lower your rate, it would probably say no. After all, you signed a contract at a certain interest rate and the lender wants its money.

Lucky for you, in today’s competitive market, plenty of other lenders are eager to get your business. When you refinance, you simply take how much you still owe — the balance of the loan — to another bank, credit union or online lender. It pays off your existing balance and creates a new loan; then you start sending your monthly payments to the new lender.

If you meet the requirements, refinancing your car loan for a smaller payment could allow you to put more into savings, investing or a home improvement project. Or, you may be able to pay off your car sooner. All of these options are better than pouring your money down the drain by paying more interest than you need to on a car loan.

3. Who should refinance

If you’re considering refinancing a car loan, there are several situations in which it makes sense. Even if you’re satisfied with your current loan, it doesn’t hurt to see if you can save money on interest.

Refinancing your car loan makes sense if:

your credit has improved
When you bought your car, maybe your credit history wasn’t great. Say you wound up with a loan at a 6.5% interest rate. If you’ve kept your payments up to date for a year or so, your credit has probably improved. You might be able snag a lower interest rate. This will lower your monthly payment and save you money in interest over the life of the loan.

interest rates have dropped
Interest rates fall for a variety of reasons: a changing economic climate, increased competition in the banking industry, even regulatory changes. If interest rates are lower now than when you first got your car loan, refinancing is likely to lower your rate and could help you pay the loan off sooner. Or, it could save you money on interest. It only takes a few minutes to apply for refinancing and see if a new lender — a bank, credit union or online lender — will offer you a lower interest rate.

a car dealer marked up your interest rate
When you got your existing loan, the car dealer might have charged you a higher interest rate than you could have qualified for somewhere else. Sadly, this often happens to shoppers who don’t check their credit score before buying a car. They are persuaded to take the dealership’s loan because they didn’t shop around for the best interest rates. The good news is, you can undo the damage by refinancing and getting a new loan at a lower interest rate.

you can’t keep up with payments
Maybe you got overexcited at the dealership and bought a car that’s really too expensive for you. You might be struggling to keep up with payments. Or maybe you’re facing unexpected financial challenges because of a job change or other circumstances. By refinancing your car loan, you can take more time to pay it off, and this will lower your payments. You should think carefully before taking this course of action. If you extend the loan term, you’ll pay more in interest over the life of the loan. That’s not optimal — but it’s better than damaging your credit by missing payments.

4. How to refinance

Shopping for a better auto loan — and refinancing your current car loan — is quick and easy, thanks to the speed and convenience of the Internet. The application process often takes less than an hour, and many lenders promise to give you a decision on your loan in a matter of minutes.

Still, the process will go faster, and you’ll get better results, if you’re organized and focused in your search for a new loan. Here are the steps to take to successfully refinance your auto loan:

Collect your documents
Find a recent payment stub from your current auto loan and make sure you know the following:

Monthly payment.
Amount of time left to repay the loan in months, often called the loan term.
Interest rate you are paying.
Customer service number of the lender in case you have questions.

Dig out your original loan contract and verify that there are no prepayment penalties. If you can’t find your contract, don’t worry. The lender’s customer service department can give you the information you need, or even email you a copy of the contract.

You’ll also need the following items to complete loan applications:

Driver’s license.
Vehicle identification number (VIN) of your car.
Pay stubs from your current employer or proof of employment.
Social Security number.

Evaluate Your Credit History
If you’ve made all your car loan payments on time for a year or more, your credit has probably improved and there’s a good chance you can benefit from a refinance.

Of course, that’s only true if you’ve also kept all your other financial commitments up-to-date. The proof is in the numbers, so you’ll have to find out where you stand. There are two ways to handle this.

You can pull your own credit report for free to see if you have any problems, such as late payments. But there is sometimes a small charge to get your FICO credit score. Since you are checking your own credit, this kind of research will not lower your score. However, because each of us has a lot of different credit scores, the score you uncover won’t necessarily tell you exactly what interest rate to expect on your new loan.

Your alternative is to apply for a new loan and find out how good your credit is as a result of the application. Apply to several car loan refinance companies so you can compare interest rates and find your best offer. Since the application process doesn’t cost you anything, you will quickly learn if you qualify for a lower interest rate.

One word of warning: Make sure you submit all your loan applications within a 15-day period. Similar queries in this time period are grouped together and treated as one. The applications, when grouped in a short period, will trigger a small drop in your credit score, about five points, but no further damage to your credit history.

Run the numbers
Using an auto loan calculator, type in your balance (from your current lender) and the new interest rate you’re being offered. Set the loan term at the number of months that are remaining on your current loan. You will then see the new — and hopefully lower — loan payment.

Decide whether refinancing makes sense
By now, you should be able to tell if you’ll save money by refinancing your car loan. In some cases, interest rates might also have fallen since you took out your current loan. If that happened, you’re in luck: There might be even greater savings and it’ll be very clear that refinancing is for you.

In some cases you may see only a small difference, or none at all. Another thing to consider is that you might be close to the end of the loan, in which case an auto loan refinance may not produce enough savings to be worthwhile.

Evaluate the Terms of the Loan
If you decide to refinance, you can leave the length of your loan unchanged, or consider these options:

Pay off the loan more quickly. If you’re used to making loan payments of a certain amount, you can keep the payment the same but shorten the length of the loan. This will save money by lowering the amount of interest you pay over the life of the loan.
Take longer to pay the loan. If your budget is stretched and you want a little financial breathing room, you could extend the loan term by a few months or even a year in order to lower your payments. This isn’t really recommended because you’ll pay more interest in the long run. However, it’s better than missing payments and damaging your credit history.

Complete the Process
If you decide to refinance, just complete the application with the lender you choose.

Follow the instructions provided by the lender. It will send you the paperwork, and all you have to do is respond to its requests. Here’s a quick overview of what you can expect:

Your new lender, the refinance company, will pay off your old loan.
A new loan will be created for you, at a new interest rate, with the term length you choose.
You’ll sign new loan documents.
You will begin making payments to your new lender at a lower rate.

While there may seem like a lot of details to take care of, the entire process can be completed in a few hours.

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