When to Refinance a Car Loan

Woman reviewing literature in showroom with vehicles
Peter Cade / Getty Images

If you borrowed to buy a car, you’re not stuck with your original loan. You might be able to save money with a better loan, and that’s easy to do if you refinance your existing loan. So when can you refinance, and how does the process work?

You do not need to wait any minimum amount of time before refinancing your car loan. In fact, you can refinance immediately after buying – even before you make your first monthly payment.

Just be sure that you actually end up with a better deal and that you don’t end up paying more for your vehicle.

To refinance, you’ll need:

  1. A new loan with better terms or pricing than your existing loan.
  2. Information about your existing loan, including the current lender and loan balance.
  3. Information about your vehicle.
  4. Documentation of your ability to repay.

Refinancing doesn’t always make sense – even if you’ll end up with a lower payment. But there are several situations when refinancing is a good idea.

A Better Interest Rate

If you can borrow at a lower interest rate, it might make sense to refinance. That lower rate (assuming all other things are equal) means you’ll pay less for your car after you take interest costs into account. Because the interest rate is also part of your monthly payment calculation, your required payment should decrease. As a result, you’ll have slightly better cash flow each month.

If you can replace your existing loan with the same loan at a lower rate, it’s best to refinance as soon as possible. Most auto loans are amortizing loans, which means you pay a fixed monthly payment with interest costs built into the payment.

You’ll pay down your debt over time, but most of your interest cost is paid at the beginning of the loan – so get that rate down sooner than later to start cutting costs.

 An amortization table can show you how much you’ll save.

Better Credit Scores

If your credit has improved since you got your existing loan, you have the opportunity to get a better loan. You might qualify for a lower rate, lock in a low fixed rate, or be able to get a cosigner removed from the loan.

When you make payments on time (or negative items fall off your credit reports after seven years or more), your credit improves. Those successful payments can raise your credit scores to the point where you have more options. Even a year or so is enough time to see improvement – so it’s worth finding out if your scores have improved enough to qualify you for a better loan.

Lower Monthly Payments?

Refinancing can result in lower monthly payments, but that’s not always a good thing. If you get lower payments as a result of a lower interest rate, you may end up saving money (as long as you refinance at the beginning of your loan period). If you just add years to your loan, you’ll pay more.

How to Refinance

To get a new loan, you’ll need to apply with a new lender. In most cases, the process is relatively painless — your lenders will work together to handle everything behind the scenes, and you just need to submit an application.

To get prepared:

  1. Gather information about your existing loan. Your most recent statement from your lender will have everything needed.
  2. Get information about your vehicle (if you won’t have the vehicle with you). Your VIN, make, model, and year will all be helpful to have on hand.
  3. Get proof of income so that lenders can verify that you have the ability to repay your new loan. Several recent paystubs should be sufficient, but check with your new lender for details.

Submit your application, along with any required documentation, and respond to any lender questions. Most lenders can give you an answer on the same day you apply, but some institutions might need a day or two to review your application.

Mistakes to Avoid

Refinancing might be tempting, but it’s easy to end up spending more money than you need to.

Avoid the most common pitfalls – especially if you only have a few years left on your auto loan.

Stretching it out: A longer term loan usually means you’ll end up paying more for your car. It might be tempting to switch from a 48-month loan to a 72-month loan, but you’ll probably pay more in interest over the life of that longer loan than if you leave things as they are. Longer terms lead to lower payments – which can provide meaningful relief in your cash-flow situation. But the overall cost of these loans is higher (that’s counterintuitive since you see a lower payment). Again, an amortization table can show you how your interest costs add up over time.

Going upside-down: Extending the life of your loan also leads to your loan being upside-down. Put another way, you’d owe more on your car than it is worth. To get rid of the car, you’d have to write a check to your lender or keep making payments on a car you don’t use anymore, and that’s never a good place to be.

You’re required to keep making payments (to avoid damage to your credit) even if the car breaks down and becomes unusable. It’s best to pay off loans quickly so that you can easily sell (and possibly buy a different, inexpensive car) if the need arises.

Prepayment penalties: Although rare with most auto loans these days, prepayment penalties still exist. Make sure it won’t cost you to pay off your existing loan early. Penalties can eat up any savings you’d get from a lower interest rate.

Waiting too long to refinance: If you’ve run the numbers and you know it makes sense to refinance an auto loan, waiting can cost you. Rates are generally best on newer vehicles, and some lenders won’t refinance loans for cars over a certain age (seven years, for example). You might even get a “new car” rate if you refinance immediately after buying from a dealer and taking advantage of dealer incentives. Used car loan rates are typically higher than new car rates.

Missing payments: Stay involved during the refinancing process, and don’t assume anything is completed. You might think your existing loan has been paid off, and you can stop sending payments, but any delay in the process can result in a “missed” payment – which will damage your credit and your ability to refinance. Confirm with both lenders before you stop sending money.

Where to Refinance

Any lender with competitive rates and fees is worth a look. For many borrowers, a local bank or small credit union is a great option.  Those institutions tend to offer low rates, and they’re often more flexible about loan size and credit issues. Online lenders are another good source – you can take care of everything when it’s most convenient and get a great rate online.

Get rates from at least three lenders, and do all of your shopping within a few weeks. When lenders make inquiries into your credit, your credit scores fall slightly. Numerous inquiries become a problem over time, but you’re not penalized for shopping rates — just submit all of your applications within 14 to 30 days.