how does car refinancing work

How Does Refinancing a Car Work?

Refinancing a car loan is the process of replacing your original auto loan with a new one. That much is obvious, but how does refinancing a car work

Depending on your situation and credit profile, refinancing could save you money through a lower interest rate, a longer repayment period, or both. It can also give you an opportunity to add or remove a cosigner.

The refinancing process can take up to two weeks to complete, and you may have to pay a few fees to process the new loan. But before you pull the trigger on a car refinance, read this guide.

How does refinancing a car work?

“Borrowers should consider refinancing their loan if they didn’t get the best deal on their loan the first time around, if their credit scores have improved, or if interest rates have dropped,” says Sonia Steinway, president of Outside Financial, an online auto lender.

Refinancing a car loan makes a lot of sense for most borrowers because it increases flexibility”

In other words, it rarely makes sense to refinance unless you can get a better interest rate out of the deal. But in some cases, getting a new loan with a longer repayment period can lower your monthly payment.

Here are some steps you can take to refinance your car loan.

1. Check your credit

It generally doesn’t make sense to refinance a car loan if your credit score is the same or worse than it was when you got your first loan. So, be sure to check your credit score to see where it stands.

Borrowers should consider refinancing their loan if they didn’t get the best deal on their loan the first time around.”

If there’s been a significant improvement, you could qualify for a much better rate than what you’re currently paying. But even if the improvement is small, it’s possible that you can still score a better rate from a different lender.

2. Get your documents together

Before you apply, make sure you have all of the documents ready that you’ll need to submit with your application.

Required documents can vary by lender, but be sure to have:

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  • Proof of income and employment
  • Proof of residence
  • Vehicle information
  • Proof of insurance
  • Payoff letter from your current lender

3. Shop around

Once you’ve decided to refinance your car loan, you can start by comparing several auto lenders to see which offer decent interest rates.

All states charge title transfer and re-registration fees, although they’re usually less than $100 combined.”

Many auto lenders, especially ones with an online presence, will allow you to get pre-qualified for a loan with just a soft credit check. This process will give you an idea of the interest rate you might expect from that lender if you officially apply.

In addition to interest rates, also look at fees and penalties. “Some lenders charge application fees and some charge origination fees,” says Steinway.

“All states charge title transfer and re-registration fees, although they’re usually less than $100 combined.” Steinway also recommends checking with your current lender to see if it charges a prepayment penalty.

4. Pick a lender and apply

Once you know which lender you like, go to the bank or credit union’s closest branch or apply online. If you have all the required documents ready to go, the process shouldn’t take too long to complete.

If you get approved, the lender will share the loan’s interest rate, term, and fees.

Make sure to read the fine print to avoid potential hidden fees or terms you don’t agree with. If everything looks good, though, accept the offer and start the process of paying off your other loan.

5. Pay off your existing loan

Most auto lenders will send a check directly to your existing lender to pay off your loan. But others may simply cut you a check and allow you to pay off the loan.

If your lender does the latter, make that payment right away. The longer you keep that cash in your checking account, the easier it will be to spend it on something else, and you could be in trouble with both lenders.

Is it worth it to refinance my car?

It all depends on your situation and what kind of deal you can get through refinancing. Here’s a quick example of how it can save you money.

Let’s say your original loan is for $20,000 and your current lender has you paying 8% interest on a 60-month loan. Your monthly payment is $415, and you’ll pay $4,910 in interest over your five-year loan term.

Now, let’s say you’re 18 months into your loan and you have about $15,000 left. You’ve improved your credit score since you first got the loan, and one lender offers you a 48-month term with a 4% interest rate.

With this new loan, your monthly payment would be $339, and you’d pay just $1,257 in interest. If you hold onto your current one, though, your payment is still $415, and you have $3,661 left in interest on the loan.

Of course, there are fees involved with refinancing. But saving more than $2,000 in interest will far outweigh whatever fees you’ll pay in the process.

The lender will need to do a hard pull of your credit, which can reduce your score although by a small amount.”

In other words, refinancing your car loan is a no-brainer if you can score a lower payment and interest rate. And keep in mind that you can refinance as many times as you want. So, if your credit score improves again, you can refinance again.

What does refinancing a car loan do to your credit?

“The lender will need to do a hard pull of your credit, which can reduce your score,” says Steinway, “although, typically, by a small amount.”

Also, keep in mind that, if you apply with multiple lenders in a 30-day period, you’ll usually only get one inquiry for that whole period rather than multiple. So, don’t be afraid to really shop around.

Beyond that, there’s not much impact to your credit score. Since your new loan and your old loan are for the same amount, there’s no change in how much you owe.

And as long as you continue to make your payments on time, your payment history will continue to help boost your credit score.

The bottom line

“Refinancing a car loan makes a lot of sense for most borrowers because it increases flexibility,” says Steinway.

“Borrowers can save money over the length of the loan by lowering their interest rate or extending the term, or pay off the loan faster by shortening the term.”

Consider all your options before choosing a lender. Start with your local credit union, then branch out from there. Don’t take the first deal you see, though, because there could be a better deal elsewhere.

To make your search easier, consider using SuperMoney’s auto loan engine. This tool makes it easy to get pre-qualified offers from several auto lenders all in one place.

As you use this tool and other methods to compare lenders, you’ll have a better chance of finding the one that can help you save the most money.

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