How to refinance a car and tap into potential savings
Learning how to refinance a car could save you thousands in interest payments on your auto loan.
Contributing Writer at Tally
August 17, 2020
If you're one of the 95% of Americans who own a car, you may be paying too much on your auto loan.
You can refinance your car loan and lower your interest payment. Many people are more inclined to refinance a mortgage, perhaps because of the longer loan term. But with the federal funds rate so low and the average interest rate on car loans dropping, you may want to talk to your lender about refinancing your current auto loan.
In this article, we outline everything you need to know about how to refinance a car loan so you can understand whether auto loan refinance is possible for you and how to get a lower rate.
What is auto refinancing?
Auto refinancing is when you replace the current loan you're using to pay for your car with a new one. Typically, refinancing brings about a lower interest rate and new loan term.
Because your new interest rate is lower than the one on your original loan, you'll end up saving yourself money in the long run. The amount that you pay in interest will be lower than what you're currently paying.
If the interest rate on your current loan is already less than the current national average for auto loans, then it is not in your best interest to refinance. In this case, you already have the best interest rate available, and it would be unlikely for you to find a lower monthly payment while keeping the same loan term.
What are the benefits of refinancing?
There are numerous potential benefits to refinancing your current car loan. Here are the three that could have the biggest impact on your financial situation.
Lower interest rates
The most obvious benefit of refinancing is lower interest rates. Lower interest rates can lead to lower payments, saving you money.
For example, let's say that you have a current interest rate (APR) of 5.08% on a loan balance of $10,000. You have 24 months remaining on the loan. Your monthly payment is $439 per month, resulting in a total payoff amount — loan principal and interest — of $10,536.
Now, let's say that you refinance your existing loan and decrease your auto loan rate from 5.08% APR to 4.08%. Your estimated payment drops to $435 per month. The total payoff amount decreases to $10,440. This results in savings of $96 because of the better terms on the new loan.
The cost savings can vary depending on your:
Remaining loan amount
Speak with your lender or use a refinance calculator to find out how much you could save by switching to a better loan.
Lower your monthly payment
Refinancing a loan could also help your personal finances because it could lower your monthly payment.
For instance, using the above example, let's say that you were struggling to make the $439 per month payment on a 5.08% APR.
You refinance your loan to receive a longer term. Now, instead of having to pay off the loan within 24 months, you extend the term to 36 months. This drastically reduces your car payment to $300 per month, freeing up $139 per month in cash that you can put toward groceries or other essentials.
If you have an emergency and need to free up cash quickly, refinancing to extend your loan terms and lower your monthly payment could be a viable strategy. However, you're going to end up paying more in the long run by doing so.
Using the example above, if you kept the loan terms at 24 months, your payoff amount would be $10,536. By extending your loan terms, you lower your monthly payment. But you must make those payments for longer.
By extending to 36 months, your payoff amount would be $10,800. While you free up $139 per month, you also need to make loan payments for an additional 12 months, costing you $264 more.
When you refinance your auto loan, you don't necessarily need to stick with your current lender. In fact, if you work with a new lender, you could find yourself eligible for potential savings.
Many lenders offer special discounts for choosing to refinance with them. You may want to contact different banks in your area to discuss your potential refinance loan options. Also, don't be afraid to work with online lenders. Many of these companies offer exceptional customer service.
Another example of a discount you could receive when refinancing is on your car insurance. During refinancing, your lender may adjust the value of your vehicle, which could end up reducing your insurance premiums.
However, if your lender increases the value of your car, your premiums may increase too. Be sure to mention this to your lender during the refinancing process so that you have a full understanding of how your financial situation is impacted.
Are there potential downsides to refinancing?
Although refinancing may be tempting, you need to consider the whole picture. There are some downsides associated with refinancing your auto loan.
One of the biggest problems with refinancing is that there are often fees associated with doing so, including:
Prepayment penalty fees
These fees can vary drastically from lender to lender. You must consider these fees when comparing your cost savings.
For instance, in our first example, you would have saved $96 by refinancing. If your fees were $100 though, you would have ended up losing money.
Harm to your credit score
The auto refinance process requires you to submit a new loan application. Doing so could harm your credit score, as it causes a new inquiry to appear on your credit report.
If you don't have any big financial milestones coming up, this may not be a big deal. But if you're looking to do something like purchase a home, you may not want to ding your credit score to refinance your auto loan. This is especially the case if you're straddling the line between good and great credit.
Your car history comes into play when refinancing. When applying, you need to provide your vehicle identification number (VIN) to lenders so they can check your car's age and collision history.
Many lenders won't refinance a car if it's more than eight years old or has more than 100,000 miles on it.
How to refinance a car
If you think refinancing could be worthwhile, here are the steps you need to take.
1. Ensure your finances are in order
You need to have an exceptional credit score to get the best rates on an auto loan. If you have a poor credit score, your lender may not be willing to refinance.
For example, let's say that you first secured your loan when you had a FICO Score of 690. After missing a few monthly payments, your credit score dropped to 590. The rate on your current loan is probably the best you are going to get. Refinancing won’t be possible.
If you have a bad credit history, focus on making on-time payments and reducing your debt utilization to help boost your credit score. If you're struggling with debt reduction, consider using a service like Tally to help.
Tally combines all of your debt payments into one monthly payment on a line of credit. A line of credit is an amount of money that a lender agrees to provide you. Each month, Tally will automatically pay your balance on credit cards and other high-interest debts.
You then make one monthly payment to Tally to pay down your credit line. Not only does this make it easier for you to manage your money, it can help you pay down debt faster, freeing up cash for other financial goals.
2. Gather necessary documents
Your lender needs basic information, including your Social Security number, VIN and personal financial statements. The lender uses this information to run a credit check. Your lender may also require you to provide proof of auto insurance.
3. Consider pre-qualification
If you're unsure about whether you're eligible for refinancing, you can search for pre-qualification offers. The lender looks at your information to determine whether you meet certain criteria. Pre-qualification doesn't mean approval, but it also doesn't result in a hard inquiry on your credit report. Being prequalified increases your chances of having your loan application accepted.
4. Apply for the loan
Once you have found an offer that you're happy with, it's time to apply for the loan. You need to provide your personal information to your lender for this to process.
Because applications will result in a hard inquiry on your credit report, you want to try to submit as few loan applications as possible.
5. Move away from your old loan and start making payments
When you refinance, you open a new loan to pay off the debt on your old loan. Although the lender for the new loan is in charge of this, you're still responsible for gathering the correct paperwork and ensuring that your old loan is properly transferred.
Refinance today to save money on your auto loan
With auto rates so low, now is a good time to consider refinancing your car loan. However, refinancing is not for everyone. Whether it's right for you depends on numerous things including the type of car you own, the balance on your loan, your credit score and your personal financial situation.
Make sure you talk with lenders to determine how much you can save by refinancing. Consider not only how much you can lower your monthly payment, but how much you'll end up paying in interest in the long term. Refinancing can have long-lasting implications.
Remember: If you're not yet in the position to refinance, Tally can help you start paying down debt from credit cards and other lines of credit. Improving your credit score will open up lending options in the future.