Refinancing a car loan allows you to take out a new loan to pay off an existing loan. The hope is that the borrowing terms on the new loan will be more favorable than what you had previously, saving you money.
After deciding to refinance your auto loan, it is best to get quotes from various lenders, so you can compare them and choose the loan that is right for you. Learn more about the details of refinancing an auto loan below:
How Does Auto Refinancing Work?
Once you settle on a lender, you can apply for a refinance loan. As part of this process, you will need to present proper documentation to the lender, which likely will include:
- Personal information, such as your social security number and a list of your most recent addresses
- Financial information such as proof of income and testimony about how much you pay in monthly mortgage or rent
- Evidence of auto insurance such as an insurance card or declarations page
- Details about both your car and current loan. You may need to tell the lender about the make, model, mileage, and identification number of your vehicle. In addition, you may have to provide the balance of your current loan, and the loan terms
After being approved for the loan, you use the refinance loan to pay off the old loan. Either the new lender will pay off the old loan directly, or you will receive a check that you will use to pay off the old loan.
Once you’ve paid off the old loan, you will begin payments on the new loan. Individual banks have their own requirements for refinancing, so you should discuss these with your lender and make sure you understand the details. Also, make sure you understand the terms of the refinance loan before signing on the dotted line. For example, you may owe a prepayment penalty if you pay off the original loan ahead of schedule.
Be careful about taking on a new loan with a longer repayment period than your original loan. Stretching out payments over a longer loan period can indeed help lower your monthly payment. However, it may prove more costly, as you may pay more in interest expenses over the life of the loan.
Will Refinancing My Car Lower My Payment?
Generally, refinancing a car loan will indeed lower your car payment. For example, you can expect a lower payment if the new loan has a significantly lower interest rate than your original loan had.
You can also lower your payment simply by stretching out the loan term. For example, if the original loan was for 48 months and then you quickly refinance to a period of 60 months, your monthly car payment will almost certainly drop.
Because refinancing often lowers your monthly payment, it can be a smart move, particularly if money is tight. A lower monthly payment frees up money that you can use to pay off other debts or simply to live more comfortably day-to-day.
However, while a lower monthly payment appears to save you money in the short run, you may end up paying more over the long haul. For example, although getting a loan with a lower interest rate might lower your monthly payment, it could cost you more money than it saves you if the lender charges high fees on the refinance. The risk of high fees wiping out the savings of a lower interest rate is particularly high the nearer you get to paying off the loan.
Similarly, while switching from a 48-month loan term to a 60-month loan term likely will reduce your monthly payment, you will probably pay more in interest costs over the loan’s lifespan. As a rule, the longer the loan term, the costlier the loan will be for you. It is important to carefully weigh all of the pros and cons of refinancing rather than simply assuming a lower monthly payment is automatically the right choice for you.
Is Refinancing an Auto Loan a Good Idea?
Refinancing an auto loan can be a brilliant idea for some borrowers. For others, it does not make sense and can be financially counterproductive.
Typically, an auto loan refinancing is worth considering if you can lower your monthly car payment by getting the new loan. For example, if your credit score has improved since you applied for the original loan, you may be able to snag a lower interest rate on a new loan. It also can be the right move if prevailing interest rates have fallen since you agreed to the terms on your original loan.
Some people refinance to a longer-term loan simply to free up additional money to pay for other expenses. After all, a lower monthly car payment means more money for other things. There are even situations where people refinance into a car loan with a shorter term. Although this can increase their monthly payment, it can also save money in interest costs over the life of the loan.
However, it’s essential to do your homework before refinancing because simply switching to a loan with a lower rate does not always guarantee you will save money. When you refinance, you may pay fees, including transfer costs and prepayment fees, that can negate some of your savings.
Also, when you extend the term of your loan, you almost inevitably pay higher interest costs over the life of the loan. If your primary goal in a refinance is to save money overall, extending the term of your loan is unlikely to help you achieve that dream.
How Long Should I Wait Before Refinancing an Auto Loan?
The best time to refinance depends on your goals and circumstances. Unfortunately, there is no “one size fits all” recommendation for when you should get a new car loan. Experts generally agree that the earlier you refinance a car loan, the more money you are likely to save. That is because if you refinance early and get a better interest rate, you will save more money since you still have more of the loan remaining to pay off.
In addition, the interest costs of a loan typically are frontloaded more to the beginning of a loan term than later on, when you will begin to pay down more of the loan’s principal. So, if you wait too long to refinance, you will miss out on many potential savings in terms of how much you pay in interest costs.
However, there are a few potential drawbacks to refinancing very early in the term of a loan. For starters, you may not qualify for a refinance if you try to get one too early in your loan term. When you buy a new car, it depreciates quickly. You may soon owe more on the loan than the car is worth. In such situations, it can be tough to get an attractive refinance loan deal.
Also, remember that it may make more sense to keep your current loan if you already have a great rate. For example, interest rates on used car loans tend to be higher than those on new car loans.
Finally, it may make sense to wait to refinance until your credit score recovers from the hit it took when you applied for your first loan. In most cases, the decline in your score will be slight, and your score will bounce back quickly. But if you want to be extra careful, it may pay to wait until this happens so you will qualify for the best rates.
Can I Lower My Car Payment Without Refinancing?
In some cases, asking your lender to lower the car payment without a refinance might be successful. For example, you might negotiate a lower monthly payment or even defer some payments. Such requests are more likely to be successful if you have a long history of making on-time payments with your lender. The lender is also more likely to agree if your request to lower the car payment is for a single month or a short period.
Be aware, though, that asking for and receiving a longer-term adjustment to your loan without refinancing is not common. In most cases, it only will be approved if you are undergoing hardship or struggling to make your payments.
In addition, you will still owe interest on the amounts left unpaid. So, deferring payments or having your monthly payment spread out over an extended period might result in the loan costing you more money over time.
If a lender rejects your request to modify the loan without a refinance, you still have options. For example, you could reconsider and pursue a refinance after all. If a refinance is not an option and you simply can’t make your payments, you could sell the car. Or, in a worst-case scenario, you could volunteer to give the vehicle to your lender.
Does Refinancing Start Your Auto Loan Over?
When you refinance a car loan, it does not push the “restart” button on your old auto loan. Instead, the new loan pays off your old loan. In effect, your original auto loan disappears, and the new loan takes over.
In some cases, the lender that approved your refinance loan will pay off the original loan directly. When this is the case, you should request proof that you made the payment and the title transfer occurred. Keep this information for your records. In other situations, the lender may issue a check to you, and you will be responsible for paying off the original loan.
After you refinance, you will remain responsible for paying off the entire amount you owed on the original car loan. However, if you get a better interest rate on the new loan, your monthly payment could go down. In that sense, refinancing can indeed be a “do-over” for those trying to lower their monthly costs.
Because the refinance loan is not a refreshed version of your old loan, the lender that issues the refinance loan will pull your credit score during the loan approval process. This is known as a “hard inquiry,” and it can negatively impact your credit score. Fortunately, even if your score dips, the impact should be mild, and your score should bounce back relatively quickly.
Finally, remember that since you will be closing out your original loan, you may be subject to a penalty for prepaying your loan in full. This is not the case with every loan, but be sure you understand how your loan works.
How Much Can Refinancing My Auto Loan Save Me?
Many variables influence how much you can save when you refinance your auto loan. Factors that determine your savings include:
Prevailing Interest Rates
Are interest rates generally falling or rising? You are more likely to save money during a period when rates are falling.
Your Credit Scores
A good credit score will help you qualify for the best auto loan rates. By contrast, if you have bruised credit, you likely will pay more.
Your Loan Terms
As a general rule, the longer your loan term, the less you will save in interest costs. For example, if you switch from a 48-month loan to a 60-month loan, your monthly payment likely will fall, but your overall costs probably will rise. On the other hand, if you shorten your loan term in a refinance, your monthly payment will likely rise while your overall costs will fall.
Fees Associated with Refinancing Your Auto
Fees–including an application fee for pulling your credit, a fee for pulling data on your car to make sure it hasn’t been in a significant accident, and a fee for transferring the title from one lender to another–can reduce the amount of savings you get to pocket. However, they are typically modest.
Some auto loans have a prepayment penalty that kicks in if you pay off the loan in advance of the agreed-upon loan term. In such instances, the penalty can eat into your savings from a refinance.
What is Debt-to-income Ratio
Lenders calculate your debt-to-income ratio by dividing your monthly income by your monthly debt payments. If you have paid off debt and decreased your DTI ratio, you may qualify for more favorable terms on a refinance that can save you money.
Many factors come into account when refinancing an auto loan. From your payment terms and potential fees to changes in your credit, refinancing an auto loan may look different depending on your unique circumstances. Gravity Lending is focused on getting the best terms and repayment options for customers. Contact our specialists to learn more.