When to Refinance a Car Loan

How Soon Can You Refinance?

Woman reviewing literature in showroom with vehicles
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Your auto loan isn’t a life sentence. If you borrow money to purchase a vehicle, it’s smart to verify that you’re not paying more than you need to. You might save money by refinancing into a better loan, and it pays to know how that process works.

When Can You Refinance?

You do not need to wait any minimum amount of time before refinancing your car loan. You just have to meet all the requirements for the new loan to refinance. Refinancing is possible 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 refinancing doesn’t cause you to pay more for your vehicle.

In some cases, you may be unable to refinance until you have documentation from your state’s Division of Motor Vehicles (DMV). Gathering registration details may slow you down somewhat.

What You Need to Refinance

To refinance an existing loan, you need the following :

  1. A new loan with better terms or pricing than your existing auto loan
  2. Details about your current loan, including the current lender, your account number, and your loan balance
  3. Information about your vehicle, including the make, model, year, and VIN
  4. Documentation of your ability to repay, such as pay stubs or tax returns

The Best Reason to Refinance: Pay Less Interest

The ability to borrow at a lower interest rate is a primary reason to refinance a loan. That lower rate (assuming all other factors are equal) means you pay less for your car after taking all of your borrowing costs into account. Because the interest rate is also part of your monthly payment calculation, your required payment should also decrease. As a result, managing your monthly cash flow becomes an easier task.

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

Over time, you pay down your debt, but you pay most of your interest costs at the beginning of the loan—so get that rate down sooner than later to start cutting costs. An amortization table can show you exactly how much you can save by refinancing.

Lower Monthly Payments?

Refinancing can lead to lower monthly payments, but that’s not always a good thing. If you achieve lower payments as a result of a lower interest rate, you may end up saving money (as long as you refinance near the beginning of your loan period). But if you wait several years before refinancing, you restart the interest cycle and amortization process described above, and you pay interest for several more years. That can end up costing more, despite the lower monthly payments.

If you’ve improved your credit scores since you got your original loan, you may be able to get a better loan. You can qualify for a lower rate, lock in a low fixed rate, or possibly even remove a cosigner from the loan.

Your credit improves when you make on-time loan payments (or when negative items fall off your credit reports after seven years or more). Those successful payments can raise your credit scores to the point where you increase your borrowing options. 

Even one year is enough time to see improvement—so it’s worth finding out if your scores have risen enough to qualify you for a better loan.

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 pay more for your car. It might be tempting to switch from a 48-month loan to a 72-month loan, but you typically pay more interest over the life of a longer loan. Longer terms lead to lower payments—which can provide meaningful relief when cash flow is limited. But the overall cost of a long-term loan 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 can also lead to your loan being upside-down. Put another way, you may owe more on your car than it is worth. To get rid of the car, you would have to write a check to your lender or keep making payments on a vehicle you don’t use anymore.

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

Prepayment Penalties

Prepayment penalties still exist, and you might have to pay extra if you pay a loan off before the term is up. Make sure it won’t cost extra to pay off your existing loan early. Penalties can eat up any savings you get from a lower interest rate.

Waiting Too Long to Refinance

If you run the numbers and you determine that it makes sense to refinance, waiting can cost you. Rates are typically lowest on new 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 purchasing from a dealer and taking advantage of dealer incentives. Used car loan rates are typically higher than new car rates.

Missing Payments

Stay involved throughout 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. Any late payments will hurt your credit and your ability to refinance. 

Confirm with both lenders before you stop making payments.

How to Refinance

To get a new loan, you need to apply with a new lender. In most cases, the process is relatively painless—your lenders work together to handle the logistics, and you simply need to submit an application.

To prepare:

  1. Gather pertinent information about your existing loan. The most recent statement from your lender should have the details you need.
  2. Get information about your vehicle (if you won’t have the vehicle with you). Your VIN, make, model, and year are all helpful to have on hand.
  3. Prepare 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. Many lenders can provide an approval decision on the same day you apply, or within a few days.

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 interest 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 whenever and wherever it is most convenient, as well as find excellent rates 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 drop 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.

Article Sources

  1. Federal Deposit Insurance Corporation. "Refinancing Loans: Not Just for Mortgages." Accessed July 6, 2020.

  2. Consumer Financial Protection Bureau. "What Is Amortization and How Could It Affect My Auto Loan?" Accessed July 6, 2020.

  3. Federal Trade Commission. "Free Credit Reports." Accessed July 6, 2020.

  4. Federal Trade Commission. "Financing or Leasing a Car." Accessed July 6, 2020.

  5. Consumer Financial Protection Bureau. "Can I Prepay My Loan at Any Time Without Penalty?" Accessed July 6, 2020.

  6. Consumer Financial Protection Bureau. "What Is the Difference Between Dealer-Arranged and Bank Financing?" Accessed July 6, 2020.

  7. Consumer Financial Protection Bureau. "What Effect Will Shopping for an Auto Loan Have on My Credit?" Accessed July 6, 2020.