What Does Refinancing a Car Mean and Should You Do It?
Written by
Marc Guberti
Edited by
Elizabeth Constantineau
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If you recently bought a new car, you may still have a few years left on your auto loan. These loans have the same monthly payment and rate, but some people might not be happy with their current arrangement.
However, you can still change the term and rate of your loan through auto refinancing. You can get a different rate, end up with lower monthly payments and use a car refinance to achieve other objectives. This guide will reveal how it works, how to get an auto refinance and key details to consider.
What Does Refinancing a Car Mean?
A car loan refinance allows you to replace an existing auto loan with a new one. The new loan typically has better terms that suit your budget.
Here are a few key points to know:
- Borrowers who want lower monthly payments can take out a loan with 1 to 2 additional years to spread out the monthly payments.
- You also might get a lower rate if market rates have dropped or your credit score has improved.
- You can either work with your current lender or get an auto refinance from a new lender.
- The principal from the new loan goes toward paying off the current loan. Then, you make payments under the new loan agreement.
How Does Refinancing a Car Work?
A refinance allows you to replace your current auto loan with a new one. You can follow this six-step process to go from assessing your current loan to closing on a new one:
- Step 1: Check your current loan terms:
- You should start by reviewing your interest rate, balance and payment schedule.
- Checking this information can help you assess what types of changes you are hoping to obtain through a refinance.
- Step 2: Compare lenders and rates:
- You shouldn’t commit to the first lender you find.
- Also, you can do business with a different lender from the one that you’re currently using.
- During this research stage, you should consider banks, credit unions and online lenders for the best rates.
- Step 3: Apply for prequalification:
- If you apply for prequalification, you can see what types of rates you can get without impacting your credit score.
- Step 4: Submit a full application:
- You will have to provide financial documents and credit information.
- The prequalification gives you an idea of what you can get, while a full application gives you actual offers.
- This application will result in a hard credit check.
- Step 5: Get approved and pay off the old loan:
- The new lender handles this for you and pays off the old loan.
- Then, you’ll have the new auto loan.
- Step 6: Start making payments on the new loan:
- At this stage, the refinance is complete.
- You will have to follow the new loan agreement with the adjusted terms.
Pros and Cons of Refinancing a Car Loan
Pros
- Lower interest rates: If you currently have a 10% APR on a 5-year auto loan and can secure an 8% APR with a refinance, you may end up saving money in the long run.
- Lower monthly payments: Extending the loan’s duration and getting a lower interest rate can reduce your monthly payments and free up space in your budget.
- Shorter loan term: Some borrowers shorten the loan term to pay off their debt faster. However, a shorter loan term typically comes with higher monthly payments. In the long run, you won’t pay as much interest with a shorter loan term.
- Remove a co-signer: Some borrowers can only get the best rates if they have a co-signer. If the borrower built up their credit score and can now qualify for better rates on their own, a refinance can take the co-signer off the hook.
Cons
- Possible fees: You may incur closing costs from your new lender and early payment penalty fees from your current lender. It’s good to calculate how these fees can impact the return from a refinance.
- Extended loan term risks: Adding more years to the back end of the loan can lead to higher interest payments. The loan balance can also be worth more than the automobile.
- Temporary credit impact: Applying for refinancing can cause a slight dip in your credit score due to a hard inquiry. This isn’t a big deal if you aren’t applying for a mortgage, credit card or another significant financial product for the next 6 to 12 months.
When Should You Consider Refinancing Your Car?
Refinancing your car can be a great financial move in the right context. These are some of the scenarios when it may be a good idea.
- Interest rates have dropped: Lower interest rates reduce your monthly payments. If you can get a better rate through a refinance, you can save a lot of money in the long run.
- Your credit score has improved: A higher credit score will make it easier to secure a lower interest rate than the rate on your current loan.
- You’re struggling with payments: In this case, you can get a refinance that adds more years to the backend of your loan. Tacking on an extra 1 to 2 years to your auto loan will spread out the monthly payments and reduce them in the process.
- You want to pay off your loan faster: If you want to get out of debt faster, you can shorten your loan’s duration. Borrowers who have 4-year loans can refinance into 3-year loans to get out of debt one year earlier. However, this type of refinance will result in a higher monthly payment.
What Changes When You Refinance a Car Loan?
This side-by-side breakdown shows how a refinanced loan can differ from your original auto loan — and where you might save.
| Factor | Original Auto Loan | After Refinancing |
|---|---|---|
| Interest Rate | Often higher, especially if credit was lower at signing | May qualify for a lower rate with improved credit |
| Monthly Payment | Set at the start of the loan | Could decrease with a lower rate or longer term |
| Loan Term | Fixed duration | Can be shortened or extended — depending on the refinance |
| Total Interest Paid | Typically higher over time | Potential to pay less overall if rate or term improves |
| Co-Signer | May be required based on credit score | Might be removed if your credit has strengthened |
Final Thoughts
Refinancing an auto loan can help you secure lower monthly payments. You can also opt for a shorter loan term if you want to get out of debt sooner. These financial products are versatile, and knowing your financial situation will help you decide which type of refinancing strategy is right for you.
However, you shouldn’t rush to do business with your current lender. While your current lender may end up having the best rate and terms, it’s good to reach out to multiple lenders and compare offers. That way, you’ll end up spending less money on your car loan refinance.
FAQ
Here are the answers to some of the most frequently asked questions about refinancing a car.- What does refinancing a car mean?
- Refinancing a car involves getting a new loan and using those proceeds to pay off your old auto loan.
- How does refinancing a car work?
- Refinancing a car involves taking out a new loan. You pay off the current loan, and then you have to stick with the rate and terms of your new auto loan.
- Will refinancing lower my monthly payment?
- Refinancing can lower your monthly payment if you secure a lower interest rate or extend your loan's duration.
- Can I refinance my car loan with bad credit?
- Yes. You can refinance your car loan with bad credit. However, you may have fewer options and end up with a high interest rate.
- Does refinancing affect my credit score?
- In the short run, your credit score may go down due to a hard credit check. However, your credit score can go up in the long run if you continue to make on-time payments.
- How soon can I refinance a car loan after getting it?
- You can technically refinance a car loan immediately after getting it if a lender agrees. However, it's better to wait several months so you can trim the balance. Refinancing too often will result in many fees and interest accumulation.
- What documents do I need to refinance my car loan?
- You will need to supply the following:
- Proof of income
- Proof of residence
- Proof of insurance
- Current loan information
- Your vehicle identification number
- Your lender will outline which additional documents are required during the loan application process.
- You will need to supply the following:
- Is refinancing worth it if I'm close to paying off my car?
- It's typically not worth it to refinance if you are close to paying off your car. Refinancing your loan will come with various costs, such as origination fees, closing costs and prepayment penalty fees.
- Each lender has different fees, but those extra costs can keep you in debt longer. It may be more beneficial to hold out a little longer so you become debt-free sooner.
Shahin contributed to the reporting for this article.
