How Does Refinancing a Car Work?
Refinancing your auto loan is a very simple, straightforward process. You essentially apply for a new auto loan, which pays off your current loan. This results in a new interest rate, a new loan agreement, and a new loan term (the length of your loan in months).
Should I Refinance My Car Loan?
Car owners will generally refinance their auto loans for three different reasons.
- Lower the interest rate
- Lower the monthly payment
- Decrease the amount of time to pay off the loan (the term).
Depending on your current situation, an auto refinance could achieve any of these results or even all of them.
For example, let us assume you are one year into your current auto loan. Your original loan amount was for $35,000, at an annual percentage rate of 9%, on a five-year term and a monthly payment of $726.
| Loan amount: | $35,000 |
|---|---|
| Interest rate: | 9.0% |
| Loan term: | 5 years (60 months) |
| Monthly payment: | $726 |
| Total interest paid over the life of the loan: | $8,600 |
After a year of making regular payments, you decide to refinance your existing auto loan. You qualify for a loan amount of $29,000, a new lower rate of 5% APR* and a lower term of four years. This lowers your monthly payment to $667 per month, pays the loan off within the original five years, and saves you just over $2,600 in total interest.
| New loan amount: | $29,000 |
|---|---|
| Interest rate: | 5%* |
| Loan term: | 4 years (48 months) |
| Monthly payment: | $667.00 |
| Total interest paid over the life of the loan: | $5,971.00** |
**Interest paid first year of original loan $2,915 plus total interest of new loan of $1,054.89.
Benefits of refinancing a car loan
- You can pay less in interest.
- Your monthly payment may be lower.
- You can pay off your car loan sooner.
What are the consequences of refinancing a car?
The downside of refinancing is you might have to pay some fees. Depending on your lender, you may owe a prepayment penalty for paying off your loan early. Your refinance lender could also have application or origination fees. Assess the total amount you’ll be paying in fees and determine how it compares against how much you’ll save in refinancing.
How to Refinance a Car Loan
If refinancing is the best option for you, here are the steps on how to refinance your car loan.
- Determine the value of your car. Estimate what your car is worth using resources like Kelley Blue Book and Edmunds.com. If you owe more than what your vehicle is worth, you likely won’t be able to refinance until you get into a positive equity position.
- Check your credit. Knowing your credit can help you understand how easy it might be to be approved for a loan and determine an expected interest rate.
- Gather documents for your loan application. You’ll need:
- Your driver’s license
- Proof of insurance
- Proof of income
- Your Social Security number
- Loan details, like your remaining balance, current monthly payment, amount of time left on your loan and interest rate you’re paying
- Vehicle information number (VIN)
- Research lenders and compare rates.You can apply to lenders that offer pre-qualification with a soft credit check to receive loan offers with rate and payment estimates. This will help you get an idea of whether refinancing will improve your loan repayment and which financial institution to go with.
Instant Offers
Get a personalized offer for an atuo loan without impacting your credit score.
- Apply to refinance your auto loan. Refinancing starts your loan over, so you’ll receive a new loan with the new rate and term length you agreed on with the lender. Your new lender will then either pay off your old car loan or provide you with the funds to pay it.
Related content:
When Should I Refinance My Loan?
A good rule of thumb is to consider refinancing your auto loan when interest rates have dropped or when your financial situation has improved.
As mentioned above, a lower interest rate can help in a lot of ways. You can free up cash each month with a lower monthly payment, pay off the loan sooner and save on the total amount paid over the life of the loan.
However, many car owners will refinance if their financial situation has improved since their original loan. Maybe your credit score has increased, or you simply did not shop around for the best rate with the first loan.
Whichever circumstance you are in, an auto refinance can have a considerable improvement on your current loan and financial situation.
When Should I Avoid a Refinance for My Auto Loan?
With any auto loan, the amount of interest paid decreases each month during the length of the loan and the amount of principal paid increases each month. A good way to think about it is the interest is paid on the front end of the loan and the principal is paid on the back end.
With that said, if you are towards the end of your loan, it may not make sense to refinance your auto loan since you have paid most of the interest up front. Sure, it may lower your monthly payment, but overall, the refinance could cost you more in the long run.
Auto Refinancing Frequently Asked Questions
What is the process of refinancing a car?
After checking your credit and determining that refinancing is the best option for you, research lenders and compare their auto loan rates. You can apply to lenders that offer prequalification with a soft credit check to get an idea of what your new rate and payment will be. When you decide on a lender, simply apply to refinance with them with an auto loan. They will then either pay off your old car loan or give you the funds to pay it off.
How long does an auto refinance take?
Good news! Refinancing your auto loan can be quick and can often be completed within the same day of your application.
Is my credit pulled when I apply for an auto loan?
Yes, any time you apply to refinance your current auto loan, you are creating a “hard inquiry”. All this means if the lender will review your credit report as part of their decision-making process for your new loan.
Keep in mind, the hard inquiry may cause a small dip in your credit score because a new loan often means added debt to the credit reporting agencies. With added debt, the chances of a borrower missing a payment increases, thus lowering your overall score.
However, once the credit reporting agency sees the old loan paid off, the amount of debt decreased and a few monthly payments made on time, your credit score should increase again.
Does refinancing a car hurt your credit?
Refinancing your car loan may initially lower your credit score a few points. Applying for a loan generates a hard inquiry, but the impact to your credit score is temporary. Refinancing may be worth it if rates have dropped since you took out your loan.
If I shop around for rates, will that hurt my score more?
No.
This is not true. The credit scoring agencies of both FICO and Vantage are aware this is happening, and they encourage borrowers to shop around. Making multiple hard inquiries within a few weeks’ span will behave as one single credit pull as far as your score is concerned.
A common misconception is if you shop around for rates and have your credit pulled multiple times, this will hurt your credit score beyond doing just a single application.
Related content:
Where to Refinance Your Car Loan
You can refinance your auto loan by visiting your local OneAZ Credit Union branch . If you do not have time to visit a branch, you can schedule an appointment with a banker on your computer, phone or tablet, or call the OneAZ Virtual Team at 800.453.9897 to apply. Or click here to apply online in five minutes or less.
With that said, if you are towards the end of your loan, it may not make sense to refinance your auto loan since you have paid most of the interest up front. Sure, it may lower your monthly payment, but overall, the refinance could cost you more in the long run.
In addition, you do not have to be a current member at OneAZ Credit Union to apply for a loan. Click here to learn what it means to be a OneAZ member.
Key Takeaways
- Refinancing your auto loan means applying for a new auto loan that pays off your current loan. This results in a new interest rate, a new loan agreement, and a new loan term.
- It's a good idea to consider refinancing when interest rates have dropped or when your financial situation has improved.
- Avoid refinancing if you’re nearing the end of your loan term, because you’ve likely paid most of the interest up front.
- To apply for an auto refinance, you will need proof of income, proof of auto insurance and your current auto registration.
Related calculator:
When interest rates drop, it’s the perfect time to refinance a loan to lower your monthly payment and to save money on the life of the loan. Perhaps you’ve heard of a mortgage refinance, and maybe you even took advantage of low mortgage rates by refinancing your home loan. But did you know you can refinance your auto loan, too?
Refinancing your auto loan is kind of like finding surprise money! Many people don’t realize they can save money and lower their monthly payment. If you are in a situation where you feel your interest rate may be too high, your payment too much, or you simply want to see what your options are, an auto loan refinance may be exactly what you need.
Now that you understand how simple the process is and what to look for to determine when it is or is not a good idea to refinance, take the next steps to lower your current rate. Click here to start your refinance application online!
By Chris “Peach” Petrie,
Founder of Money Peach
Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.
APR = Annual Percentage Rate
