How to Refinance a Car Loan

Refinancing an auto loan can save you hundreds of dollars in interest payments. In this article we walk through when and how to refinance a car loan.

When most people hear the word “refinance,” their minds automatically jump to home refinancing. After all, your home loan is likely the one that will take you the longest to pay off. So it’s the one that typically benefits the most from a refinance.

But did you know you can also refinance your car loan? This is an especially good option if you could get a much lower interest rate on a new car loan. This can save you tons of money and also help you pay off your car more quickly.

Interested in refinancing your auto loan? Here’s how:

Know When to Refinance

First, you will, of course, want to keep an eye on whether or not you should refinance. You’re likely a good candidate to refinance if one or more of the following applies to you:

• You’ve seen auto loan interest rates drop. This is the least likely scenario as of the time of this writing, especially if you financed your car through the bank. After falling gradually from 2008 until about 2014, car loan rates have started to trend back upwards. Still, it’s a good idea to keep an eye on industry trends to be sure you’re still getting a good rate.
• You’ve boosted your credit score. According to this auto loan interest rate calculator, your credit score can make a huge difference in what you’ll pay in interest on your car loan. On a $10,000 used purchase loan, you could pay an average of 15.58% interest with poor credit, or an average of just 2.73% with excellent credit. That’s a huge difference! If your credit score has increased several points since you financed your car, look at your new expected interest rate.
• You just didn’t get that great a deal on your financing. Maybe when you bought your car you didn’t know how to get the best financing deal. It may be time to shop around again to see if you can get a better rate, even if your credit score and overall interest rates have held fairly steady.
• You need to decrease your payments. Are you struggling to make your car loan payments? In this case, a refinance could get you into a lower payment by extending the repayment term. This isn’t a great option, if you can avoid it. But it can be a reasonable way to trim your budget without having to give up your car.

If one or more of these situations sounds familiar, you should at least look around to see what deal you might get by refinancing your car loan.

Find Your Break-Even Point

Before you actually shop around to refinance your car, first find out if it’s actually a good idea financially. Sure, saving a few percentage points on your interest rate seems like a good idea right off. But there are costs involved with refinancing. So be sure your savings will outweigh your costs.

To do this, you need to calculate your break-even point. This is the point–usually a number of months–at which your savings will begin to outweigh your costs.

To calculate your break-even point, first figure out if there are any fees involved with refinancing your car. This might include early termination fees on your original loan, transaction fees for your new loan, and potentially new state registration fees. Some states require borrowers to re-register their cars after a refinance. Add all that together, and that’s how much your refinance will cost.

On the savings side, get an estimate of how much you’ll pay on your refinanced loan. You could use a calculator like this one to estimate your payment based on your loan balance and credit score. Look at how much that will save you per month. Then, divide your overall cost by your monthly savings.

This is easier than it sounds. Let’s say your refinance will cost you a total of $500 in fees, but you’ll save $50 per month on your loan. It will take you 10 months to break even. After 10 months of car payments, you’ll start saving money.

Shortening Your Term

Calculating your break-even point can be tricky if your refinance leaves you with a larger or similar loan payment because you’re also shortening the term. If you can significantly cut down on your interest, you can pay off the loan more quickly for the same monthly payment. This is a good option if your payment is affordable and you want to get out of debt more quickly.

In this case, though, you’ll need to calculate your overall expenses versus your overall savings. You can do that using an amortization calculator like this one. Put in your current car loan terms and current principal. See how much you’d pay in interest over the rest of the life of your loan as is. Then put in your current principal with the new loan terms. What’s the difference in interest payments?

In our first scenario, where a refinance would cost $500, if you save $501 by refinancing, you’re saving money. Of course, it’s up to you to decide how much you need to save in total to make the effort of the refinance process worth your while.

Shop Around for New Financing

If you decide you’re likely to save money by refinancing your car, it’s time to shop around. There are plenty of aggregators online that let you shop with multiple auto loan lenders at once. You might try a couple of these, but don’t leave out alternatives like your local credit union. You can often get the best financing deal from a credit union.

Keep in mind that you should do all of your shopping for your refinance within a two-week period. Each time a lender pulls your credit history to see if they’ll lend to you, it counts as a hard pull on your credit report. These can ding your credit score by a few points. However, algorithms like FICO’s are set up to let you roll several inquiries into one if they’re for the same type of loan.

But this only works if you consolidate your shopping around into a 14- to 45-day span, depending on the particular FICO score a lender chooses to use. The best option is to keep to a two-week period. That way you know your rate shopping won’t harm you, no matter which FICO score a lender uses.

Once you find the best financing deal, you can move on to the next step.

Get Your New Loan

Getting a new auto loan is typically pretty simple. You get your documentation together, usually including the car’s information and documentation about your income. Then you fill out the application for funding. In the last step, you may have filled out preliminary applications. At this point, you’ll likely need to provide things like actual proof of income.

If the new lender approves the terms, they’ll typically work behind the scenes with your existing lender. The new lender will pay off the balance on the loan, and then they’ll take over the title. Once you pay off that loan, they’ll send you the title to the car that you now own free and clear.

Topics: debt

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