In many areas of the United States, having a car is essential, and most people need an auto loan to purchase one. However, you don’t have to stick with your original auto loan for its entire duration.
You can take advantage of auto loan refinancing, which allows you to potentially lower your car payment, reduce your interest rate, and improve your repayment terms. We went straight to an auto-financing expert, our vice president, indirect lending, Rick Seamann to help explain how to refinance a car loan.
What Is Auto Loan Refinancing?
Auto loan refinancing is when you take out a new auto loan to pay off your existing one. You then make monthly payments to your new lender as you did with your previous loan.
Seamann says this new loan “should have a different interest rate and terms, ideally better for your financial situation than your current auto loan.”
Reasons People Refinance Their Auto Loans
Seamann is no stranger to the refinancing world and says, “people choose to refinance for many reasons. Refinancing is all about making it easier for individuals to reach their financial goals, whether paying off their car faster or reducing their monthly payment.”
For example, two individuals may have completely different reasons for refinancing a car. One may seek a solution to reduce their monthly payment and find that extending their loan term can do just that. Another may want to pay off their vehicle faster and find it beneficial to shorten their loan term. “Either way,” says Seamann, “refinancing could help both individuals achieve their financial goals.”
How to Refinance Your Auto Loan in 5 Steps
Refinancing your auto loan could be the key to significant savings. Here’s our simple 5-step guide to refinancing your car loan.
Step 1: Realize You Could Benefit from Refinancing
The first step in refinancing is realizing you could benefit from it! Whether you need to lower your payment or see that market rates have dropped, it’s important to be proactive about refinancing your auto loan.
“As soon as you know you cannot afford your payment, contact your lender immediately. Waiting too long and missing too many payments could decrease your options for refinancing,” says Seamann.
Step 2: Contact a Lender and Gather Your Documents
As part of the process, you can choose a new lender to refinance with or contact your current lender. Do your research to compare rates, terms, and find a trustworthy lender. Some lenders might have an auto loan promotion you may qualify for that you could take advantage of. You’ll want to gather the required documents you’ll need to start the process, such as your driver’s license, vehicle registration, and current payoff with your lender. At this stage, you’ll want to know any application fees a lender may have. Depending on the lender, these fees can range from $20-100.
Step 3: Discuss Your Financial Needs and Wants About Refinancing
“It’s important that your lender listens to you and determines the best way to refinance based on your financial wants and needs,” says Seamann. “They should recommend a strategy that will help you reach your financial goals, whether you want to lower your payment or pay your car off faster.”
Step 4: Go Through the Approval Process
When applying with a lender, you must complete a credit application. Whether you get approved or denied depends on numerous factors, including the information on your credit application, your current auto loan balance, and your car’s value.
Step 5: Finalize the New Loan and Pay Off the Old One
Once you get approved for a new auto loan, the last thing you’ll need to do is sign the paperwork for the new loan and pay off the old one. There are two ways to pay off your existing auto loan. Seamann says the most common option is “your new lender will send a check directly to your old lender to pay off the loan. A second option is for your new lender to hand you the check to give to your old lender. Either way, ensure that the check pays off your existing loan.”
Once your old loan is paid off, you would pay your new lender as usual.
When Does Refinancing an Auto Loan Make Sense?
Seamann says, “it’s important to consider how you want refinancing to benefit you.” Everyone’s financial situation differs, so talking to a lender about the specifics is likely your best bet. Here are some common scenarios that may help determine if refinancing is right for you.
Lowering Your Interest Rate
A lower interest rate can significantly reduce the amount of interest you pay over the life of the loan. Seamann shares that there are two ways you may be able to score a lower interest rate: if your credit score has improved since getting the loan or if market rates have decreased.
Let’s look at an example of how a lower interest rate could save you money.
| Loan Amount | APR | Loan Term | Monthly Payment | Interest Paid |
| $20,000 | 12.00% | 6 years | $391 | $8,152 |
| $20,000 | 8.00% | 6 years | $351 | $5,248 |
*Rates and terms are for example only.
Refinancing from a 12.00% interest rate to an 8.00% interest rate could save you $2,904 in interest and bring down your payment by $40 per month.
Reducing Your Monthly Payment
One way to reduce your monthly auto loan payments is with a lower interest rate. Another way to achieve this is by extending the loan term. However, there is a trade-off that Seamann wants you to consider. “When you extend your loan term, you’re making smaller payments for longer, which, over time, leaves you paying more interest. However, if it’s a way to keep up with your car payment, it could be a trade-off worth taking.”
Reducing the Amount of Interest Paid
Say you want to pay as little interest as possible through the life of your loan. You could do this by shortening your loan term. Seamann advises that this could be done when you really want to pay off your car since “shortening your loan term will increase your monthly payment.”
Removing or Adding a Cosigner
Removing or adding a cosigner to a loan is also possible through refinancing. You may want to remove a cosigner if you had no or poor credit when you got the loan, and the financial institution required you to have one. Once your credit improves, you can refinance to remove the cosigner, taking full responsibility for the auto loan. The same can go for adding a cosigner to the loan.
Switching to a New Lender with Better Terms
You can also refinance when you want to switch lenders. “Whether it be poor customer service or wacky loan terms, your reason for switching lenders could vary. But the process to switch lenders would be the same as the overall refinancing process,” says Seamann.
When Should You Avoid Refinancing Your Auto Loan?
Refinancing isn’t for everyone, and there are certain situations where refinancing may not be your best option.
You’re Close to Paying Off the Loan
Refinancing may not be worth it if your loan has a smaller remaining balance. Seamann shares his expertise by pointing out that “many lenders have a minimum term and/or loan balance they will fund, and if you’re under that threshold, you likely won’t qualify.” However, if you have a low loan balance and desperately need to lower your monthly payment by extending your loan term, a lender may be able to work with you.
You Have a Prepayment Penalty
When you get your initial auto loan, Seamann urges you to read the terms and watch for something called a prepayment penalty. “A prepayment penalty is when a lender charges a fee for early payoff or refinancing. The cost of a prepayment penalty varies, but it does make refinancing more expensive. Prepayment penalties on auto loans are not too common, but it could be a pain if you really need to refinance and get caught in one. Ask your lender if your loan has a prepayment penalty before looking into refinancing.
Your Car’s Value Has Dropped Significantly
One of the factors lenders use to determine your eligibility for refinancing is your car’s value. When your car’s value is less than your loan balance, that is called being “underwater” on your car loan. In Seamann’s experience, “being underwater can make refinancing a little more complicated. Lenders usually won’t extend credit when they know they wouldn’t recoup the full loan amount if you default.” Getting underwater could happen when the car depreciates faster than you make your payments, or if your car is wrecked and you do not follow car buying strategies like having Gap Insurance.
Pros and Cons of Refinancing an Auto Loan
Refinancing can be an excellent opportunity for many borrowers. However, that doesn’t mean there are never drawbacks to it. Here are some pros and cons to consider.
Advantages of Refinancing
Refinancing can lower your car loan interest rate, lower your car payment, shorten or extend your loan term, help you remove or add a cosigner, and allow you to switch lenders. All these things could help you in your financial journey!
Potential Drawbacks to Consider
Seamann says it best – “if you need to refinance, there shouldn’t be a drawback.” Think of it this way: If you are in a tough spot financially and are struggling to keep up with your car payment, you could refinance and lower your payment, or you could avoid refinancing and potentially default on your loan.
There are a couple of drawbacks to consider when refinancing, such as a higher carrying cost or paying on the car longer when you extend the loan term. However, refinancing is the way to go if you need a smaller payment.
Frequently Asked Questions About Auto Loan Refinancing
Is It a Good Idea to Refinance a Car Loan?
Like everything that involves finances, Seamann says whether you should refinance “depends on your financial needs and wants. If you’re in trouble and need a way to make smaller payments on your auto loan, look into refinancing. Don’t wait to reach out to your lender. Be proactive!”
How Soon Can You Refinance a Car Loan?
“Unless you have a prepayment penalty, you can refinance as soon as the initial loan funds,” says Seamann. “That’s usually within a week. I see a lot of refinancing happen right away when borrowers want to add their title, tax, and licensing to their loan amount.”
What Credit Score Do You Need to Refinance a Car?
Each lender has a slightly different way of approving borrowers, so there is no magic credit score that will get you approved everywhere. However, having a good credit score (a VantageScore of 640 or more) is always a good thing to strive for! A good credit score may get you a lower interest rate or better loan terms.
At Centris Federal Credit Union, we have auto refinancing experts like Seamann who are ready to help! If you want to refinance your auto loan, check out our refinancing options, start your application, or view our current auto loan rates here.
Federally Insured by NCUA.
