What is car refinancing & how does it work?

You might choose to refinance a car loan for many reasons, from potentially lowering your monthly car payment to reducing your total interest costs over the life of the loan. If you’re thinking about refinancing your auto loan, it’s important to understand how refinancing works. The process is surprisingly straightforward, but there are a few key things to consider before you apply for auto refinancing.  

What does it mean to refinance a car and how does it work? 

When you refinance a car loan, it means you pay down your existing loan with a new auto loan—usually from a different lender. You’ll make payments to the new lender until your loan is paid off, and the new lender’s name will appear on your car’s title. While refinancing won’t lower your total loan amount, you may benefit from more favorable terms.^[1]   

For example, if your new car loan has a lower interest rate, your new loan will accrue less interest each month. Even if you do not qualify for a lower interest rate, you could still lower your monthly payment by extending the length of your loan term. This strategy could be helpful if your finances have changed and you need some extra wiggle room in your monthly budget.  

Alternatively, if you can afford a higher monthly payment, choosing a loan with a shorter term might help you score a lower interest rate. 

When could auto loan refinancing be a good idea? 

It’s important to consider timing when refinancing your existing car loan. Here are a few situations when auto loan refinancing often makes sense.   

• Your financial situation has improved. You may want to shop for auto loan refinancing if your income or credit score have increased since you first took out your auto loan, or if you’ve paid off debts and have a lower debt-to-income (DTI) ratio. The changes could help you score a lower interest rate or more favorable loan terms if you refinance.^[1] 

• Market interest rates have dropped. Even if your personal situation hasn’t improved, market competition impacts auto loan rates. When interest rates fall, lenders may offer lower rates to attract new customers. Check rates with multiple lenders to see if you might benefit.  

• You didn’t shop around for your first loan. Dealerships can markup rates which may may result in higher interest rates and longer loan terms.^[2] If you originally financed your auto loan through a dealership, you may qualify for better loan terms through a bank or lender. In some cases, the terms may still be better even if your financial situation or market interest rates haven’t changed.  

• You want to lower your monthly payment. Sometimes lowering your monthly payments takes priority over getting a lower interest rate. If you need to free up room in your monthly budget, refinancing your auto loan could help you get a longer term and lower monthly payment.   

When could refinancing your car loan not be a good idea? 

Sometimes it’s better to wait before refinancing your auto loan. Here’s a closer look at times when you should hold off.  

• You can’t get a lower interest rate. If market interest rates have gone up or your financial situation hasn’t changed, it may make sense to hold off on refinancing.  

• You’re upside down on your car loan. When you owe more on your vehicle than it’s worth, most lenders won’t allow you to refinance.^[4]  

• You don’t meet lender requirements. Many lenders won’t offer refinancing until you’re at least a few months into your current loan. On the flip side, some lenders require a longer period remaining on the loan term. If you’re near the beginning or end of the term, you may not qualify. 

• You don’t want to pay fees. Some lenders charge origination fees when you take out a new loan. In some cases, the amount is calculated as a percentage of the new loan amount and then deducted when the loan is funded. Your current loan may also charge you a prepayment penalty for paying off the loan early, often calculated as a percentage of the remaining loan amount.^[3] 

• You don’t want your credit affected. Many lenders, like LendingClub Bank, let you check your rate without affecting your credit score by conducting a soft credit inquiry. However, once you apply, the lenders usually perform a hard credit check, which could cause your score to take a temporary dip. Learn more about soft vs. hard credit inquiries.^[5]  

What do lenders look for when refinancing your car loan?

Auto loan refinance terms, rates, and requirements usually vary widely between lenders. When you finance your car loan, lenders typically consider a range of factors, including information about your vehicle, current loan, and your creditworthiness. Here are some common things lenders look at when refinancing your car loan. 

1. Vehicle age, make, model, and mileage 

Lenders may refuse to refinance certain vehicle makes and models, or they may have limits on the car’s mileage and model year. For example, LendingClub Bank requires your vehicle to be less than 10 years old and have fewer than 120,000 miles. 

2. Current auto loan balance and remaining payments 

Your existing auto loan balance and remaining payments can also be a factor. A lender might choose not to refinance a loan if it has too low—or high—of a balance, or if you’re close to paying it off.

3. Loan-to-value ratio 

Lenders may also look at the value of your vehicle relative to how much you owe on the loan, or the loan-to-value (LTV) ratio. A higher LTV can make it harder to get approved, especially if your LTV is over 100% and your car is worth less than the outstanding loan principal. This is also known as being “upside down” or “underwater” on your loan, and it can happen when your vehicle’s value depreciates faster than you pay down your loan.^[4] 

4. Debt-to-income ratio 

Your monthly debt-to-income ratio helps lenders understand how easy it will be for you to afford your monthly payments. Qualifying for a new loan can be difficult if you have a high DTI ratio.  

5. Your creditworthiness 

Lenders review your credit reports and credit score to help determine whether you qualify for a loan and to set your loan rates and terms. Having a long history of timely payments and low balances on your credit cards can help your credit score.  

How to refinance your car loan 

If you’ve decided that refinancing your car loan is a good idea and the timing is right, follow these steps to get started.  

• Shop around. Many different types of lenders—like banks, credit unions, and online lenders—offer auto refinancing loans. Check your rate at multiple companies to find a competitive offer. When done properly, rate shopping may not impact your credit score.^[6]

• Get your documents in order. Most lenders will need your Social Security number, driver’s license number, registration paperwork, and the car’s vehicle registration number (VIN). You’ll also need to know the payoff amount for your existing loan. You can usually find this online when you log into your loan account or by contacting your current lender.  

• Read the fine print about eligibility. Lenders will often have rules about which loans and cars are eligible for refinancing—for example, a minimum outstanding balance of $4,000 and fewer than 120,000 miles on the car. Save time by identifying each lender’s eligibility requirements before you apply. 

• Apply to refinance your car loan. When you’re ready to apply, it’s important to understand that most lenders use a hard credit inquiry with each application, which can impact your credit score. If you are applying to multiple lenders, consider submitting them all within a two week window. VantageScore® count all inquiries within a 14-day period for the same type of loan as just one inquiry on your credit report.^[6]

• Closely evaluate offers. Compare the terms of your existing loan against your offers to decide which one will help you accomplish your financial goals. Calculate how much you could save over the life of the loan, how much you could lower your monthly payment, and how quickly you could pay down the loan.  

• Finalize your auto refinance loan. Once you’ve accepted a refinance offer, be sure to complete all of the paperwork. If the new lender is paying off the old lender, make sure your old loan is paid in full. Or if funds were deposited in your bank account, you may need to pay off the old lender directly.   

• Make your first payment. Payments on auto refinance loans can start immediately. Be sure to note the due date of your first monthly payment, and make the payment on time.  

The bottom line 

Refinancing a car loan can be a good idea if your creditworthiness has improved, interest rates have dropped, or you want to change your loan’s terms. You could consider refinancing your car loan when you can qualify for a new loan with more favorable terms, such as a lower interest rate or monthly payment.   

Keep in mind that applying for and taking out a new loan may impact your credit score in the short term. However, in the long run, refinancing won’t necessarily hurt your credit if you make your loan payments on time.  

1. Consumer Financial Protection Bureau. “What should I know before I shop for a car or auto loan?” 

2. Bankrate. "Is it better to finance a car through a bank or dealership?"

3. Consumer Financial Protection Bureau. “Can I prepay my loan at any time without penalty?” 

4. Federal Trade Commission Consumer Advice. “Auto Trade-Ins and Negative Equity: When You Owe More than Your Car is Worth” 

5. Consumer Financial Protection Bureau. “What’s a credit inquiry? 

6. Experian. "How Does Rate Shopping Affect Your Credit Scores?"