How Does Car Refinancing Work?

When you finance a vehicle, you agree to a certain set of terms, like the interest rate, loan length, and monthly payment. If you want to change these factors, one option is to refinance your existing loan.

The process of refinancing involves swapping one loan for another, often to help you save money. If you’re thinking about refinancing your auto loan, keep reading to learn how it works, the benefits of refinancing, and what to do if you can’t refinance.

What Does Car Refinancing Actually Do?

Car refinancing is a process that allows you to apply for a new auto loan to replace your existing loan. The main purpose of refinancing is to change your loan terms.

For example, refinancing can help you lock in a lower interest rate or adjust the length of the loan if you need more time to pay it off. When you refinance a loan, the new lender pays off the original lender. Then, you start making payments to the new lender, based on the terms of the new loan.

Benefits of Refinancing a Car Loan

Refinancing a car loan has a number of advantages, especially if it can help you save money. Here are some of the biggest pros of refinancing an auto loan.

Lowers Your Monthly Payment

The main benefit of refinancing a car loan is a lower monthly payment. Whether you qualify for a better interest rate, pay more toward the value of the vehicle, or extend the loan repayment period, refinancing is a great way to secure a more affordable monthly payment.

For example, imagine your current auto loan of $25,000 has a 5 percent interest rate on a six-year term, with a monthly payment of around $400. If you were to refinance the loan to a 2.5 percent interest rate, your monthly payment would drop to around $375. Paying an additional $5,000 toward the loan principal would lower the payment even further to $300 per month. Adjusting several factors of the loan can make a big difference in the monthly cost.

Add or Remove a Co-Signer

If you have a cosigner or co-borrower on your current car loan, you might choose to refinance the loan to remove that individual from the contract. Your financial situation may have improved since you took out the loan, or maybe the co-signer is no longer in your life. Regardless of the reason, car loan refinancing often makes it easier to remove a cosigner without any obstacles.

Similarly, borrowers can also refinance to add a cosigner to a loan. The borrower might be in a different financial situation and need additional support, or they might have gotten married and want to include their spouse on the loan. Either way, refinancing can simplify the process of removing or adding a co-signer.

Pay Less in Interest

Another benefit of refinancing an auto loan is the ability to secure a lower interest rate. When you pay less money in interest, you pay less to borrow the money. If interest rates were high when you took out the loan, or if you’ve improved your credit score dramatically, you might be able to get a loan with a much lower interest rate if you refinance.

How to Refinance Your Auto Loan

If you’re currently locked into an auto loan with less-than-favorable terms, you might want to consider refinancing it. Here is a basic overview of how to refinance an auto loan.

1. Consider Your Reasons for Refinancing

The first thing to do is consider the main reasons for wanting to refinance your loan. If it’s a matter of getting a lower interest rate or extending the loan term, it could be a good option for you.

However, refinancing isn’t the right solution for everyone. Plus, you typically need to meet certain requirements around your car’s age and mileage in order to qualify.

2. Assess Your Credit

Next, look at your credit score. A low credit score makes it harder to qualify for a lower interest rate. If your credit score hasn’t improved since getting the loan, you may not find a better interest rate.

However, if your score has gone up since you took out the loan, it’s worth applying for new loans. You should also look at national average interest rates to determine whether rates have dropped since you entered into your agreement.

4. Apply for Loans

The process of applying for refinancing loans is mostly the same as applying for traditional auto loans. It’s helpful to apply with more than one lender, which allows you to compare options and terms to find the best one for your situation. Although submitting a loan application can show up as a hard inquiry on your credit report, the main reporting agencies typically view multiple applications within a short period as one inquiry.

Gather all the necessary documents before you start applying so you have the details in front of you. You will probably need the following documents to apply:

Driver’s licenseSocial Security numberProof of auto insuranceProof of incomeDocuments for your current loanVehicle information, including mileage and vehicle identification number (VIN)

5. Finalize the Loan

After receiving approval for a new auto loan, you can complete the process by signing the paperwork and finalizing the loan details. It’s important to review all the documents and terms of the loan before you sign.

Make sure you know how much you’ll owe each month and where to submit payment to avoid late fees or missed payments that can hurt your credit.

What to Do If You Can’t Refinance

If you don’t qualify for auto loan refinancing, you might want to consider these options:

Sell the Car

If you’re struggling to make your auto loan payments, you can sell your vehicle and pay off the loan with the proceeds. However, if you owe more than what you can sell the car for, this might not solve your problem completely.

Renegotiate the Loan Terms

Your lender might be open to a renegotiation of the loan terms if you explain your current situation. You may be able to pause your payments for a few months until you have more money in the bank. Some lenders can also adjust the loan terms to help you get a lower monthly payment without refinancing.

Voluntary Repossession

With a voluntary repossession, you turn your car over to the lender, which allows them to sell the car and charge you for any remaining balance. If you can’t sell your car and you want to get out of your loan quickly, this is an option. However, it should be a last resort, as voluntary repossession impacts your credit.

Finance & Insurance Editor

Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.