Refinancing your auto loan can be an attractive option if it saves you money over the life of the loan or reduces your monthly payments.
Does refinancing your car loan make sense?
There are a few scenarios where refinancing your car loan makes good financial sense:
- If your credit has improved since you took out your car loan and you could get a better interest rate. As a result, it could decrease your monthly payment.
- You’d like to shorten your loan term — this way you’ll pay the debt off sooner, forking over less in interest over the life of the loan. Keep in mind, this may have the effect of raising your monthly payment.
- Or, you need to stretch out your loan term. This has the benefit of a potentially lower monthly payment but you’ll probably pay more in interest overall. In general, it’s best to avoid this scenario, unless your financial situation has changed for the worse and you can’t make the original payments.
You could be better off sticking with your original plan if your loan has an early termination fee or early payoff penalty.
How to refinance your car loan in 5 steps
#1 Check your credit and make necessary improvements
Take a look at your credit scores. Late payments, using more than 30% of your available credit on revolving accounts, and having a lot of credit inquiries in the past two years could hurt your credit score. Making even small improvements to your credit file could help you get a lower interest rate on your new car loan, which may result in lower monthly payments. People with the highest credit scores generally receive the lowest rates. In 2018, the median credit score of auto loan borrowers at the time they took out a loan was 704.
If your credit utilization ratio is high and you can afford to pay down your credit card balances, do so before applying to refinance your car loan. Each time a lender asks for your credit score, it recalculates using the most recent information in your credit report. Since credit card companies report to credit bureaus once every 30 days, it could take a month or more to see an improvement in your score if you decide to pay down your card balances.
#2 Get your documents in order and apply for a loan
It may be possible to get a better deal with your current lender. Check with them first to see if you are eligible for an interest rate modification. This could decrease your payments immediately without the need for a new loan.
If your current lender can’t offer a better interest rate on your current loan, it’s time to shop around for better terms. Your new lender will need some information from you to process your application for a car loan:
- Vehicle identification number (VIN): This helps the lender verify that your car is valuable enough to secure a new loan for the amount you’ll borrow, since your vehicle serves as collateral for the loan. The VIN lets your lender know the car’s year, make, model, color, and engine type.
- Payoff amount for your current loan: This number may change frequently, so get the most recent figure by calling your current lender.
- Current odometer reading: Your new lender will use this as a factor in determining the value of your vehicle.
- Proof of current auto insurance
- Account number with current lender
- Contact information for the current lender
- Your personal information: This may include your contact information, Social Security number, address, employer’s contact information, your income, and your residence status.
The documentation required to qualify and execute the loan depends on the bank, credit union, or online lender you choose. Pay particular attention to their requests to avoid processing delays.
#3 Research your options and understand your current loan
You can compare rates online or visit lenders in person to fill out refinancing applications. Before you can compare new loan options, you’ll need to fully understand the terms of your current loan.
Make sure you understand whether your current lender charges penalties for paying off your loan early. Figure those penalties into your calculations when deciding whether refinancing is in your best interests.
Verify the structure of your loan contract to understand whether you pay simple interest or pre-computed interest. Simple interest, calculated on the amount you owe, means the quicker you pay off the loan, the less interest you’ll pay. Pre-computed interest is a fixed amount, calculated and added at the beginning of the contract. Even if you pay off the loan early, you still pay 100% of the interest. Auto loans are usually simple interest loans.
Understanding the structure of your current loan will help you compare your options as you seek to refinance the payoff amount. Choose terms that best fit your individual financial situation. Make sure potential lenders offer a low or no-fee simple interest loan with an interest rate lower than your current loan.
#4 Decide on a lender and accept the terms of your new loan
Upon approval, you’ll receive loan details like the total amount, fees, interest rate, length of the loan, and monthly payment. It’s up to you to decide whether the loan fits your budget and your financial goals.
When you decide to accept the terms of a loan, your new lender will pay off the previous loan. Keep your former lender informed about the situation so you can avoid late fees and penalties during the transition.
Fees. Unlike refinancing a mortgage, the fees to refinance an auto loan are typically modest. Lenders may not charge an application fee, and though you may have to pay a fee to transfer your car title with your county or state, those fees are typically less than $75.
#5 Set up payments
Your new lender provides information to help you understand your payment options. Authorizing automatic payments from your bank account is the best way to avoid late fees and protect your credit rating. Late payments have a negative impact on your credit score, which could trigger interest rate increases on other accounts. You may also be eligible for a decreased interest rate or smaller loan fees if you agree to automatic payments.
Check with your former lender to verify that it closed the account. If you made monthly payments via automatic withdrawal, make sure to terminate that arrangement.
What to watch out for when refinancing a car loan
Interest rates on car loans are rising
The Federal Reserve made the most significant increase to the federal funds rate in 10 years in September 2018. In January 2019, interest rates on new vehicle loans averaged 6.19% — this is the second-highest recorded rate in about a decade. In response to a federal funds rate increase, auto lenders often raise interest rates on car loans incrementally. More recently, the Fed decided to hold the federal funds rate at the previous level.
With generally higher auto loan rates, it may be more difficult to find a lower interest rate than your current loan. When you explore the option of refinancing your vehicle, make sure that you can secure better terms with a lower interest rate than your current loan.
You could get financing for more than your car’s value
While this may seem like great news, accepting a loan for more than your car is worth is known as being “upside down” on your loan. If you can afford to make extra payments to reduce the amount you owe, do so. Owing more money on your vehicle than it’s worth could make it difficult to purchase a new car in the future.
Read and understand the contract to avoid misunderstanding the terms of your car loan
Before accepting a loan offer, look carefully at the terms. Watch out for excessive loan origination fees and early payoff penalties. Take note of late payment penalties. Look for information about whether there’s a grace period after the monthly due date during which you won’t get charged a fee.
Ask questions about anything that isn’t clear in the paperwork. This document represents a legal commitment, so it’s crucial to avoid surprises and verify that the loan includes the terms you want most.
The bottom line
Refinancing an auto loan isn’t for everyone. If you can secure a new loan with a lower interest rate or a payment that fits more easily into your budget, refinancing could be the best way to reach your financial goals. Here are four good places to look for auto refinancing in 2019.
As low as
24 To 84
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