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When should I refinance my car loan?
Switch lenders if you can score a better rate or lower monthly payment.
Refinancing your auto loan lets you get a new loan to pay off your previous auto loan. When you apply, you’ll be given an interest rate and new monthly payment. If the total cost is less than what you’d spend on your current auto loan, it may be time to refinance.
The point of refinancing? Save money. If you’ll pay less interest over the life of the loan or you make your monthly payments more affordable, considering refinancing. If your existing loan has better terms — or a prepayment penalty — it makes sense to stay put.
Consider it if your credit improved or you recently got a raise. But if your car is older or you recently took on more debt, you might have a hard time qualifying.
2 reasons to refinance your car loan
There are two main goals when refinancing your car loan:
- Lower interest rates
- Lower monthly payments
If you want to lower your interest rate, you’ll need to have good credit and a low debt-to-income (DTI) ratio. Over the life of the loan, a lower interest rate typically means you’ll pay less money.
A lower interest rate can also lower your monthly payment. However, it’s not the only way. If you extend your loan term, you’ll decrease your monthly payment.
But it’s not guaranteed to save money. Extending your loan term will likely cost more than your current loan.
When you refinance, understand your budget and compare the overall cost of both loans. If you’ll end up paying more on a new loan, be careful. Unless you need to decrease your payment significantly, it’s better to pay less interest and cut back in other areas to make up for a higher loan payment.
When to refinance
Auto loan refinancing makes sense if you’re making large payments on your original loan or have a high interest rate. It may be time to refinance if your credit score has improved and a new loan could save you hundreds off your current auto loan.
Interest rates have dropped
The average interest rate on auto loans has stayed relatively low since the start of 2020 — even for borrowers with lower credit scores. In fact, the average annual percentage rate (APR) was 5.05% in July 2021. Of course, this is for people with good credit. The actual interest rate you receive when you refinance will depend on your financial situation.
You financed through a dealership
Dealerships are notorious for marking up interest rates to increase profits. If you got your car loan through a dealership, you might want to consider refinancing with a bank or online lender. More often than not, it can save you money and give you access to additional products and services.
You qualify for a lower interest rate
An auto loan with an APR over 10% is a sign you could be better off finding a new lender — even if your credit hasn’t improved much. This is especially true if interest rates have dropped. You may not get the lowest rate out there, but refinancing can prevent you from paying hundreds extra in interest over the life of your loan.
You need a smaller payment
If your financial situation has changed, it makes sense to want to refinance for more affordable monthly payments. A new loan with a longer term can help reduce the amount you pay each month.
But be careful. Refinancing could lead to spending more money. Even if it’s the right decision in the short term, carefully consider how much more you’ll spend by refinancing your auto loan. Fortunately, if your situation improves, you could make extra payments and potentially save money.
Your credit score has increased
Credit scores are often the most important factor when it comes to getting a good deal on an auto loan. If you’ve been making on-time payments to your current lender for the past 6 or 12 months, your credit score has likely improved. Because of this, you may be able to get a better rate on a new loan.
Your income has improved
The more you make, the less likely lenders are to consider you a risk. If your income has increased, consider refinancing for a lower rate and shorter term. If you can afford the higher monthly payment that comes with a shorter term, you could avoid paying thousands on interest in the long run.
Your debt has decreased
Credit card debt or other loans can impact your credit score — and lower credit scores often mean worse rates on an auto loan. If you’ve paid off your debt, you’ll have proof that you’re good with your finances. And this means that refinancing your auto loan could make sense.
In addition, you’ve likely lowered your debt-to-income (DTI) ratio. This shows lenders that you can afford your payments, especially if you plan on applying for a shorter term. The less risky you look to a lender, the more likely you are to be approved for a lower rate when you refinance your car loan.
You want to remove a cosigner
If you applied for an auto loan with a cosigner or coapplicant, refinance may be the only way to remove them. Check your existing loan first, though. Unless refinancing could help get you better terms, you might want to stick with your auto loan and talk to your cosigner about taking over the responsibility of making payments on your own.
When to avoid refinancing
But refinancing your car loan isn’t always a good idea. If your current lender offers solid benefits — or if your new lender isn’t as flexible — you might want to stay the course and just make extra payments on your existing loan to save money.
Your lender charges a prepayment penalty
Refinancing involves repaying your loan early. You might not save much if you have to pay extra fees to get out of your original loan contract. If you paid most of the interest on your car loan in the first few months or years, you don’t stand to save much by refinancing.
But you should also watch out for prepayment penalties with your new lender. If you plan on making extra payments, you don’t want to be hit with an extra fee that your previous lender wouldn’t have charged you.
You’re underwater on current loan
If your car is worth less than your loan balance, you’re considered underwater or upside down on your loan. Lenders are generally unwilling to refinance a car loan when you have more debt than your car is worth.
You don’t meet minimum requirements
When you look into a new lender, research more than just loan rates. To refinance a car, you need to meet minimum credit score, income and other financial requirements. If you don’t, you’re unlikely to qualify for a new car loan.
In addition, your car must meet its own requirements. Most auto refinance requires a vehicle to be under 100,000 miles or 10 years old. There are exceptions, but you may not be eligible for the loan amount you need if your vehicle isn’t up to a lender’s standards.
You’re almost done paying off your current auto loan
If you’re near the end of your current loan, applying for a new loan with a term of 60 months won’t benefit your financial situation. Refinancing can save you money, but if you don’t have much more time left on your loan, consider making extra payments instead of applying for refinance.
You plan on borrowing more in the future
If you want a new credit card or are interested in other loans, refinancing may not be the right choice. Your financial standing will be what lenders use to determine your eligibility for a variety of loans and credit options.
Since auto refinance can mean a hard pull of your credit — which will temporarily lower your score — you should wait to refinance to avoid too many hits to your credit.
You don’t have solid financial footing.
Auto loans can improve your financial situation and credit score — but only if you can afford them. If you’ve been late on payments or don’t have a regular source of income, a lender will view you as a risk. This makes it almost impossible be approved for auto refinance.
Overall, potential savings can be high
So let’s take a look at a few examples. Say you borrowed a loan of $30,000 with an APR of 9% and a term of 60 months. This means a monthly payment of $622.75 — with $7,365.04 paid in interest. After a year, you would have a remaining loan amount of $22,527.
Here’s how your monthly payments would break down if you chose not to refinance, refinanced at a lower interest rate and refinanced with a longer term.
| Loan amount | APR | Loan term | Monthly payment | Total cost | |
|---|---|---|---|---|---|
| Refinancing at a lower rate | $22,527 | 5.05% | 48 months | $519.29 | $2,398.98 |
| Refinancing with a longer term | $22,527 | 9% | 60 months | $467.62 | $5,530.41 |
| Refinancing with a longer term and lower rate | $22,527 | 5.05% | 60 months | $425.63 | $3,010.71 |
You’ll pay nearly $2,000 less in interest by refinancing with the same term and a lower interest rate. And you’ll end up with a smaller monthly payment when you do.
On the other hand, refinancing to lower your monthly payment by extending your loan term will cost over $1,000 more. So even though you’re spending about $100 less each month, you’ll wind up paying more.
Even if you qualified for a better APR, you’ll still spend more in interest when you extend your loan term.
Next steps
Refinancing your auto loan is generally a good idea. Because many lenders offer auto loan refinancing at competitive rates, you could pay less overall with a similar — or smaller — monthly payment.
If you’ve decided on this route, it’s time to compare lenders that offer refinancing. Check their eligibility criteria, including their minimum credit score and income requirements, and what interest rates are typical.
Overall, make sure any loans fit within your budget and will cut down on how much you pay for your car.
Compare options for auto loan refinancing
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