Credit Karma Guide to Refinancing Your Auto Loan
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If you’re contemplating a do-over on your auto loan, Credit Karma is here to help. In this guide, we’ll walk you through the typical process of refinancing an auto loan. With the right questions, a little research and a calculator, you may be able to score a better deal by lowering your interest rate or monthly car payment.
You’ve probably heard of refinancing a mortgage. But did you know you can also refinance an auto loan? In fact, the process of refinancing an auto loan can be a lot simpler and more straightforward than refinancing many mortgages.
Refinancing your auto loan can save you money in a number of ways. It can lower your interest rate, reduce your monthly payments and leave you with terms that make sense for you.
But as with anything involving money and credit, it pays to understand what you’re getting into. It’s easy to look at a lower monthly payment and get excited, but you should also look at the interest rate and fees, and consider them within the context of your long-term financial plans.
If you’re still not sure whether refinancing your auto loan makes sense, don’t worry. In this guide, we’ll go through some key elements, from how to apply to where you should shop for the best deal.
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Why refinance your auto loan?
Car owners may consider refinancing for a number of reasons.
Your current loan has a high interest rate
This could be because you took a bad deal on financing or couldn’t qualify for a cheaper loan at the time.
“If you bought the car and your interest rate wasn’t the best or you’ve improved your credit, it could be a good opportunity to refinance,” says Ron Montoya, consumer advice editor at Edmunds.com.
You’d benefit from lower monthly payments
Budgets change, and a lower monthly payment could help free up cash for other financial necessities. Even if you keep the same interest rate but extend the period of your loan, you could have a lower monthly payment. Just be aware that this can put you at risk of eventually owing more on your loan than your car is worth (also known as being upside down on your loan).
You want a different loan term
Maybe you’d prefer to make lower monthly payments over a longer term, or maybe you want a new loan with a shorter term and lower interest rate. Whatever the case may be, you may be able to shop terms that make better sense for you.
When does refinancing not make sense?
Refinancing may seem like a no-brainer for everyone — who doesn’t want to lower their interest rate or monthly payment? But experts warn that refinancing doesn’t always make financial sense.
Matt DeLorenzo, managing editor at Kelley Blue Book, says refinancing can be a good option if it helps you lower your rate, shorten your loan term or both. Why?
“Because [the car] is an asset that’s depreciating,” he says.
Depreciation is another way of saying that a car’s value can decrease the longer you own it. Refinancing could help you avoid a situation in which you owe more on your car than it’s worth. But it can also exacerbate that situation if you’re not careful.
For example, a loan with a lower monthly payment may also come with a longer term. The longer you spend paying off your car, the more likely the car will depreciate in value and the more at-risk you are of going upside down on your loan.
Where can you go to refinance your auto loan?
If you want to refinance your auto loan, start with the financial institutions you know and trust — for example, your own bank or credit union, says Jack Gillis, director of public affairs at the Consumer Federation of America and author of “The Car Book.”
You can also compare auto loans on the Credit Karma auto hub.
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“Keep your options open,” says Montoya. “Don’t just get a quote from one source.”
Some questions you may want to ask while shopping around:
- What’s the interest rate or range of rates for refinancing auto loans?
- What requirements do you have for borrowers or vehicles?
- What are the fees or other out-of-pocket expenses?
- What loan lengths are available?
- Are there prepayment penalties?
- What’s the total cost of refinancing, including fees, interest and principal?
Some things you need to know about prepayment penalties
You may have heard of prepayment penalties with other types of loans. The concept is simple: pay off the loan early, and you’ll get hit with a penalty fee.
It’s the financial version of “No good deed goes unpunished.”
While prepayment penalties are less typical with auto loans, it’s still a question you need to ask your original lender and any potential lenders as you shop around.
If you discover that your original loan comes with prepayment penalties, try to nail down the exact dollar amount of the fee. That way, you can calculate if the penalty is steep enough to skew your decision on refinancing.
Shopping around is shopping smart
Comparison shopping doesn’t stop after you get a quote or two. Once you have a few offers, you can go back to other lenders and negotiate.
“Show them the deal you’re being offered, and see if they can beat it,” advises Mike Schenk, vice president of research and policy analysis for the Credit Union National Association.
Don’t forget to compare your existing loan, too. You may find that it’s not so bad, considering what else is available.
When weighing different options side-by-side, focus on how much you’re paying in total — not just each month. Remember to account for the fees, the interest rate and any down payment.
Before agreeing to refinance your auto loan with a lender, ask if they offer additional ways to reduce the interest rate. For instance, some lenders may cut the interest rate on your loan if you set up automatic payments.
How important is your credit for refinancing an auto loan?
Whether you’re applying for a credit card or buying a home, your credit scores can go a long way in determining whether a lender will do business with you. So how important is your credit if you want to refinance an auto loan?
Most experts agree it can be crucial. Lenders use a number of factors to decide your auto loan rate, but two of the most important factors are your credit and debt-to-income ratio, which is calculated by dividing your monthly debt payments by your monthly income.
Generally speaking, the better your credit, the more likely you are to secure a lower interest rate. To get an idea of where you stand, you can check your VantageScore 3.0 credit scores from TransUnion and Equifax for free on Credit Karma. These may not be the same scores your lender uses to decide your rate, but they can help you better understand your overall credit health.
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Nailing down the right credit score
As far as the exact credit you’ll need for the loan you want, those requirements vary depending on the lender, says Lakhbir Lamba, executive vice president of retail lending at PNC Bank.
At PNC Bank, “our focus is on prime and super-prime,” he says, explaining why the bank typically targets auto refinance customers with credit scores from 660 to 680 and up.
PNC’s credit range of 660–680 is not necessarily the industry standard. Each lender may define prime and superprime credit differently.
If you’re confused about how to build your credit, check out our article on credit score factors and how they’re used to calculate your credit scores.
Does the current value of your car matter?
In short, yes. Just like when you refinance a mortgage, the value of the asset (your car, in this case) can be a factor in the loan.
“The value of your car is important,” says Gillis. “That can impact the amount you receive on the loan.”
To get a general idea of what your vehicle is worth, log in to Credit Karma’s auto hub. There, you’ll be able to see the value of your vehicle as estimated by the National Automobile Dealers Association.
Often, lenders will not allow financing for cars of a certain age and condition. Individual requirements vary by the lender, but it can be much more difficult to refinance a loan if your odometer reads higher than 100,000 or your car is more than a decade old.
Even so, just because you have an old car doesn’t mean refinancing isn’t worth a try. If you think refinancing could help you financially, investigate the option.
“I would not assume a specific age or mileage would knock me out of the deal,” says Schenk.
How long should the term of your refinanced loan be?
Generally speaking, the shorter the loan term, the higher the monthly payments. But stretch that loan out too long and you risk having to shoulder a car payment plus repairs on an older car simultaneously. That can be a real pinch on your wallet.
“I would caution about stretching payments too far,” says Montoya. “There’s a sweet spot between a comfortable payment and paying it off sooner.”
Remember: A shorter loan term usually means paying less in interest over the course of your loan — sometimes dramatically less. When comparing interest rates and loan terms, try Credit Karma’s Simple Loan Calculator to get an idea of how much you can save with a shorter loan term.
One strategy that might work for you is to shop for a lower interest rate while keeping the same payoff schedule. That way, you’re saving money on interest without postponing your pay-off date.
How does auto loan refinancing compare to mortgage refinancing?
Auto loan refinancing can be a bit simpler than mortgage refinancing. That makes sense, given the size of the asset involved, but there are still some similarities.
Similar: Debt-to-income and loan-to-value ratios
Just like mortgage lenders, auto lenders will often look at your other obligations. This is where the aforementioned debt-to-income ratio comes into play. They may also compare the value of the asset to the amount of the loan (this is known as the loan-to-value ratio).
Let’s dig into each of those figures a bit more.
- Debt-to-income ratio: As far as your debt-to-income ratio is concerned, the standard rule of thumb is that your DTI ratio should be less than 36%. The Consumer Financial Protection Bureau highlights 43% as another important number, because it’s generally the highest DTI ratio a consumer can have while still being eligible for a Qualified Mortgage.
- Loan-to-value ratio: When it comes to loan-to-value ratio (also known as LTV), the ideal varies widely among lenders — much like a mortgage loan, says Lamba.
Similar: Hard inquiries when shopping around
Another similarity between home and auto loan refinancing has to do with hard inquiries. If you keep all your loan applications within a set time period — generally around 14 days — they may only count as a single hard inquiry on your credit reports. Since you can’t get a loan without an inquiry, staying within that 14-day window helps you shop around for loan deals and lowers the risk of hurting your credit scores.
Different: Changes in valuation over time
One of the biggest differences between home and auto loan refinancing comes down to valuation. Cars almost always decline in value as they’re driven, whereas homes don’t necessarily lose value simply from people living in them. Other factors can impact the value of your home, like the local real estate market, but are not likely to impact the valuation of your car.
An alternative to refinancing: Double your payments
One simple alternative to auto loan refinancing is to double up on your payments.
With a car loan (as with a home loan), much of the early payments go toward interest. But when you pay extra, all of that additional money can go toward the principal. And the faster you pay off that principal, the less you have to pay in interest.
You also have to make sure your lender allows it and doesn’t impose any prepayment penalties.
Looking after your original car loan
One thing to keep front and center during the refinancing process: your original loan.
Generally, during an auto loan refinance, collateral of the car is transferred from the old lender to the new lender. If that’s the case, make sure you understand every aspect of that transaction.
“Find out if there’s a cooling-off period [right to cancel the loan] or what happens if there are complications,” Gillis urges. “You need to know what your rights are, should there be a problem with the transfer.”
Prior to accepting an offer, research “what the previous loan needs from you to satisfy it,” Gillis advises.
For that, you can either check the loan’s paperwork or call your original lender.
When you refinance, you should also receive a confirmation that the original loan has or will be paid. Don’t forget about your original loan until you have that confirmation.
If you think you might want to refinance, ask plenty of questions and get plenty of estimates from different lenders.
“No question is stupid, and no question should go unanswered,” says Gillis.
Money isn’t the only factor to consider when refinancing an auto loan. Sometimes you may also want to consider the time and effort it takes.
Start by asking yourself two questions.
- How much can I save?
- How many hoops do I have to jump through to save that money?
If you’re considering refinancing your car, here a few other stories that can help.
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Refinancing can lead to lower interest rates and lower monthly payments, but can it lead to lower credit scores? Maybe, maybe not. Whether you’re still trying to decide whether to refinance or it already happened, it’s important to remember that the story doesn’t end after you close your loan.
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