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How To Refinance Your Car Loan


There are a lot of good reasons to refinance your car loan, several of which probably brought you here.

If you feel like your car loan is shaking you down for your lunch money just like that bully in 3rd grade, you’re not alone. The most common reason we hear that people like you want to refinance is to save money.

That might be to negociate for a lower interest rate, or to settle on a shorter loan term because you got a raise at work and want to pay the loan off sooner.

Other than those two, there are a number of common, good sense reasons for you to be considering re-financing your car loan. They include:

  • Securing a better interest rate if you got poor terms of the first loan because of bad credit.
  • You’re making more money, so you decide you want to consolidate your loans to aggressively pay off debt.
  • You want more managable monthly payments because yours are currently too expensive.
  • You want to change loan types so you can pay off your loan ASAP. This can work if your current loan has repayment penalties.
  • You want to switch from a fixed to a variable rate loan to make your monthly payments more predictable.

If you’ve never refianced a car loan before, it can seem incredibly intimidating at first, but it doesn’t have to be.

There are some potential pitfalls that we’ll talk about further down, but luckily, with some due diligence and a little bit of math, you should be able to avoid all 3.

But let me back up. First things first, let’s break down exactly how refiancing a car loan works.

The Process Of Refinancing Your Car Loan Is Just Like Any Other Negotiation

In a lot of ways, refinancing your car loan is a lot like preparing for a debate. To win a debate you want to come armed with all the most up to date information about where your positions stand relative to the positions of whomever you’re debating.

1: First, See Where You Stand By Looking At Your Credit Score

Figuring out where you stand is the most important part of the car loan refinancing process.

The most important number here shouldn’t be a surprise. It’s your credit report. If you’ve been keeping up with your payments, your credit score has improved and that improvement is what’s going to lead to better rates for you because the banks see you as a less risky borrower.

Of course, there are other factors that affect your credit beyond your payment history as we can see above. Payment history only makes up 35% of your total credit score, and can still be outweighed by other factors.

For example, you may have been dilligent in paying down your car loan, which benefits you in the “payment history” and “amounts owed” category, but if you were spending by opening up new lines of credit, you’d suffer a penalty in the “amounts owed” and “new credit” category.

The only true way to see where you stand is to look at your credit report and your credit score.

Federal law allows you to check your credit report 1 per year for free. However, thanks to the ongoing COVID pandemic, Equifax, Experian, and TransUnion are currently offering 1 free credit report per week until April 2021.

To see your credit score (which is what lenders use to decide your rates) you’ll want to use a MyFico authorized vendor. Although there are a number of different credit score models out there, FICO scores are used in over 90% of lending decisions.

You can also use free platforms like CreditKarma to check your credit score as well, but the scores it shows you are not your FICO scores, which lenders actually use. It can be enough to give you a good ball park, however.

Once you have both your credit report, you want to take a look to see if your credit score has improved. If it has improved, you’re in a good spot. Credit scores above 655 will help you qualify for better car loan rates.

But even if it hasn’t, don’t be discouraged, because there’s another number we need to check first.

2: Check To See If Rates Have Changed For Your Credit Bracket

Checking to see if the average car loan rates have changed is a bit of an inexact science. There are a couple of ways to go about it.

I personally like to use Bankrate’s 3-month history of loan rates to get a good idea of where the trend is going.

Source: Bankrate

As of writing, you can see that across the board, loan rates are falling. Used car rates have fallen an average of 3.25%, while new car rates have fallen by about 2.6% percent.

While it’s not a huge difference, this is exactly the type of trend you want to see if you’re interested in refinancing your car.

If you combine falling loan rates with your credit score increasing, you’re well-positioned to save money. Even if your credit score hasn’t improved, but rates are falling, you can still save a small amount of coin.

While you may not be saving money if your credit score has not improved, there are still other good reasons to refinance as we’ve talked about.

3: Comparison Shop At Least 3 Different Rate Offers Within A 14 Day Period

At this point, you should have a good idea of where you stand financially, as well as your reasons for wanting to refinance.

All that’s left now is to apply. When you do apply, you want to make sure you do it with more than 1 lender. Studies show that on average, you’ll get the best rates when you apply to 3 or more lending companies. These should be lending companies separate from your current lending company. It’s a good idea to make sure you’ve got a good mix of lending companies as well.

Try to add credit unions, both local and statewide into the mix, as well. Credit unions tend to give the best rates if you can qualify for their higher credit loan terms.

A Word Of Caution

One thing to keep in mind: do the research for where you want to apply before you start applying. You want to be able to apply for all of your offers at once. The reason you want to do is is because of how applying for credit affects your credit score.

A credit score application requires what’s known as a “hard pull”.

A hard pull is a potential creditor requesting to look at your file to see how likely you are to repay what you want to borrow. Hard inquiries have a negative impact on your credit score for between 2-4 months on average (up to a year at most) even though they stay on your credit report for up to 2 years.

Fortunately, the “new credit” part of your credit score is only weighted at 10%, so it won’t have a disaterous effect.

If you want to get the best rate however, it pays to keep your credit score up. Credit Score bureaus have recognized that it’s considered normal behavior for consumers to shop around for major loans such as car loans and home loans.

The bureaus generally group all of these inquiries together and only count them as one “hard pull” instead of several. One hard pull will only drop your credit score by a few points, and only for a little bit.

But hey, fair warning, right?

Frequently Asked Question: Can I Refinance My Car With The Same Lender?

I strongly recommend including your current lender as an optional 4th company, because it’s almost always easier to refinance when you’re working with your current lender.

Some good reasons to consider refinancing with your current lender to refinance your car include:

  • Having an established relationship with the lender which makes it easier to go through the re-lending process.
  • Sometimes you can get lower fees as your lending company negociates to get your business.
  • A quicker path to refinancing, which could have you signing on the dotted line in a few days or weeks, instead of up to a month and change.

On a less quantitative level, it’s also a lot less intimidating to work with a company that already has all your information on file, which may be reason enough to work with them, especially if financial negotiations make you anxious.

If they do, you’re not alone.

4: Evaluate If The New Loan Offers Accomplish Your Refinancing Goal

Once you have all of the offers in hand, now you need to evaluate if they meet your refinancing goals. As we talked about before, your reasons for financing can include:

  1. Lowering your monthly payment
  2. Paying your car off faster
  3. Changing the type of loan you have (fixed rate vs flexible rate)

For most of us, I’m reasonably willing to assume it’s one of the first two, which makes calculating the difference easy.

Start with an auto loan refinance calculator. Fill out the required information for each quote, and compare each of the quotes you got to your current rate. The beauty of this calculator is that it does all the work for you!

Once you have a good idea of if any of the loans will save you money, you now need to compare the loan amount with the value of your car.

Use the Kelly Blue Book guide to determine how much your car is worth. Then, compare this amount to the amount you’re being loaned.

You don’t want your new loan balance to be worth more than you car. This is called “being underwater” on your loan, which means you owe more to the bank than the car is worth. In this case, refinancing may not be possible, although not all companies will refuse to lend depending on your credit score.

If the difference in what you’re saving is minimal, it may not be worth the hassle. Typically this is the case if the amount you owe is low, or you’re almost finished making payments.

In this case, it may not be worth the hassle.

5: If You Decide To Refinance, Make Sure The Loan Terms Match Your Refinancing Goals

Make sure you carefully consider the length of the loan as well. If you are used to making loan payments at a fixed amount, it’s possible you’ll be able to change the length of your loan while also keeping the payment the same. This means you pay the car off quicker, and get out from under the debt.

Alternatively if you need to create some wiggle room in your budget, you can extend the length of the loan until your financial situation stabilizes. This does come with the downside of you paying more interest over time though.

6: Once You’re Ready To Go, Confirm With The Lender Of Your Choice

If you’ve made it this far, congratulations. All the hard work is done.

Now all you need to do is dot your i’s and cross your t’s. The lender will send you over documents to sign, and a new loan will be drawn up with your loan terms and the interest rate you got. The new lender will then go ahead and pay off your old loan, while assuming the obligations for your new loan.

Even though there are many moving pieces, you can get this entire thing done in a few hours of work. It’s not as hard as you might think!

There Are A Few Things That May Hold You Back To Watch Out For

Just like in any debate, you need to watch out for your opponent’s verbal counters. You want to be prepared for them ahead of time so you aren’t brought into a conversation where you’re in over your head.

It’s the same principle at work here.

1: You Owe More On Your Car Than It’s Worth

We’ve already talked about this, so I’ll be brief. When you owe more than your car is worth (also called being upside down, or having “negative equity”, most lenders are going to stay away from loaning you more money.

Lenders don’t want to refinance underwater vehicles because typically they are more risky.

Unfortunately, as we’ve talked about before, new cars are expensive. With the average new car depreciating up to 10% the second it drives off the lot, you may be underwater from day 1 if you don’t put cash down.

2: Your Credit Score or Financial Situation Isn’t In Order

While a bad credit score doesn’t mean you won’t be able to refinance, it does mean that the offers you’re going to get won’t be as good as if your credit score were higher.

Lenders can only profit if borrowers repay their loans. When you have a lower credit score, that tells the lender that there’s a risk you won’t pay them back.

Granted your credit score isn’t the only factor taken into consideration. Your income, time at your job, and debt-income ratio all factor into what the lender ultimately decides to offer you.

If your credit score is on the lower end and your financial situation isn’t all that stable, it’s usually a fruitless exercise to try to refinance. You’ll be better off waiting until you have more stability – and then you’ll really be able to get a home run rate.

3: You Have An Older Car

Some banks will not give you a loan offer if you have a car that’s older than 6-10 years or so.

Generally speaking, the older your car is, the higher the interest rate on your loan. Older cars do tend to be worth less than newer cars, all else equal.

Make sure you shop around – because there are companies that will do it. Just compare the loan terms when it finally comes time for a decision.

Frequently Asked Question: What Credit Score Do I Need To Refinance My Car?

Depending on who you listen to, you’ll hear multiple different numbers thrown around when someone talks about the credit score you need to refinance your car.

There’s not really a one sized fits all answer here, but let me try to give you one regardless.

At the minimum, you want your score somewhere between 600-655 before you consider refinancing, but as always, the higher your score the better.

In my opinion though, as long as you’re above that minimum threshold, you want to instead focus on the amount your credit score has changed SINCE you got your car loan.

Looking at your credit history will help with this. If there’s a generally positive trend in regards to your credit score, and you’re above 600-655, you’re in good shape to go for it.

Just remember, the higher your credit (and your debt to income ratio) the better the loan you’re going to get.

Refinancing Can Impact Your Credit (But Not That Much)

As mentioned, there are a couple of ways that refinancing your car can hurt your credit, although they are minor and oftencases temporary penalties.

  1. The credit check (also known as a hard inquiry) will decrease your score by a few points for up to a year. It won’t be more than 5-10 points at most.
  2. If you apply for multiple loan offers in an extended period over several months, instead of being treated as one inquiry they will be treated as multiple inquires and you will be penalized for each. It’s better to do multiple applications within a 45-day window, but I do recommend doing them within 14 days if you can swing it.
  3. Closing an account does affect your credit age, even if nothing else changes. The newly originated loan will count as a fresh account instead of a potentially older one.

Recap (And One Dirty Trick To Save You Thousands)

So to recap, refinancing your car loan doesn’t have to be difficult. The entire process will take a few hours of work on your part as you check your financial health and then assess different offers from lenders.

We also covered that the lowest stress way to refinance is likely going to be to work with your existing lender.

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