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How to Refinance a Car Loan

What you'll learn: Everything you need to know when refinancing a car loan


Just like your car needs maintenance from time to time, checking up on your own financial health can help you function at your best. If you feel like you devote too much of your paycheck to your car each month, you may want to consider refinancing your car loan.

You may be wondering if refinancing can make enough of a difference to help you. Here's a rundown geared to help you understand the basics of how to refinance an existing car loan, how much you could potentially save, and more.

What Does Refinancing a Car Loan Mean?

Refinancing your car loan means you replace your existing car loan with a new one in order to lower your monthly payments or decrease how much interest you pay throughout the life of the loan.

These are some basic reasons why people may refinance a car loan:

  • To lower their monthly loan payment
  • To lower their interest rate
  • To shorten their loan term
  • To extend their loan term

Refinancing is an easy way to improve your car loan situation, but it's not right for everyone. It depends on your financial situation, your current loan terms, and more. Before we talk about how to actually get started, let's start by determining whether it's even worth it for you.

Is Refinancing Worth It?

Seeing an example of how refinancing can help you save may put things into perspective.

Let's say you take out a car loan for $20,000 over 60 months with an interest rate of 8%. That would give you estimated monthly payments of about $406. If you were to pay off your loan on time without missing any payments, you would pay a total of about $24,332. After 12 months, assuming you make all your payments on time, your loan balance would be down to approximately $16,611. Now if you were to refinance at that time and get a loan of $16,611 for the remaining 48 months with a lower interest rate of 5%, you'd end up paying a total of about $18,362 on that loan. When you add that to the amount you already paid on the original loan, your total cost would be about $21,751. That's $2,581 less than what you would have paid on the original loan.

If you want to experiment with different rates and terms, try our car refinance calculator — a quick, easy way to crunch the numbers and see your potential savings.

Pros and Cons of Refinancing a Car Loan

Now that you know the potential savings, let's hit the brakes and look at the advantages and disadvantages of refinancing your car loan.

Pros of Refinancing Cons of Refinancing
You have the opportunity to lower your interest rate and monthly payment Your refinanced loan could have a higher interest rate than your original loan
Lowering your monthly payments could increase your cash flow Some lenders may issue a prepayment penalty for paying off your original loan early
You could save money on interest if you shorten your loan term You could pay more over time if you extend your loan term

Those are some of the basic pros and cons of refinancing a car loan. But one area that could be a pro or a con is your credit score.

Does Refinancing a Car Hurt Your Credit?

Like with any loan, it's important to know the potential effects on credit scores. Does refinancing a car hurt your credit or will it raise your score?

Ultimately, reducing debt that you can't afford is a good thing. So, in the long run, refinancing can help to increase your credit score. If you do refinance, be sure to make your payments on time because that contributes to 35% of your credit score breakdown.

But as is common with taking out a loan, refinancing does require a hard credit inquiry. That means your credit score will temporarily drop up to five points when you submit an application with your lender.

If you shop around and submit multiple applications with various lenders, your credit score can drop. But, the impact to your credit score should be the same as if you only submitted one application, assuming you submit all your applications within a 14 to 45 day window.

Now that you understand the pros and cons of refinancing a car loan, let's dig into the right time of when to refinance.

When Should You Refinance Your Car Loan?

When it comes to refinancing a car loan, timing is everything. One way to determine when it's the right time to refinance is to answer these three questions.

  • Has your credit improved? If your credit score is higher now than it was when you took out the original loan, you may be eligible for a better interest rate.
  • Are interest rates lower now? If car loan rates have decreased since you took out your original loan, it may be a good opportunity to save.
  • Are your finances in a better place? If your income is higher now than it was when you took out the original loan, you may be able to lower your interest rate and shorten the loan term to save big on interest.
  • Have you lost income? If your financial situation has changed due to job loss, lower wages, etc., refinancing could be a way to lower your monthly car payments and save money each month.

If you answered yes to any of those questions, it might be the right time for you to refinance.

Other Questions to Ask Before Refinancing

You must remember refinancing only makes sense in certain situations. As you determine whether it's the right time to refinance, also consider these questions.

  • Are you close to paying off your original car loan? If you're close, getting a new loan may not be beneficial to you.
  • Do you know whether the balance of your current loan is higher than the value of your car? Being “upside down” on your loan may make qualifying for a new loan challenging.
  • Does your original car loan have a prepayment penalty? If paying off your loan early incurs a fee, refinancing may not make the most financial sense for you.
  • Will refinancing require you to pay transaction fees or fees for transferring the title or re-registering your car?
  • Does your new lender have refinancing restrictions? Some lenders won't refinance cars that are over eight years old or have more than 100,000 miles.

How to Refinance a Car Loan in 5 Steps

By this point, you probably know whether refinancing is the right choice. If you're going to refinance your loan, you should understand the process. Here's a step-by-step look at how refinancing a car works.

  1. Gather the important information
  2. Check out your refinancing options
  3. Apply to refinance your loan
  4. Transition to your new loan
  5. Start payments on your new loan

As you can see, it's a simple process. Now let's dive a little deeper into each of those steps.

1. Gather the Important Information

As you begin the refinancing process, start compiling the important information you may need.

  • Original loan info: your current monthly payment, interest rate, loan term, payoff amount
  • Current car details: make, model, year, mileage, vehicle identification number (VIN)
  • Your info and documents: proof of car insurance, proof of employment and income, proof of residence

Your new lender may need this information to evaluate your current vehicle and to help determine whether you'll be able to make your loan payments.

2. Check Out Your Refinancing Options

You'll want to shop around to find a lender that offers low rates, few fees, and an easy online process. Credit unions typically offer fewer fees, but banks may have more branch locations if you'd like to meet face-to-face with a lender. Starting your research online is a great way to begin the process.

3. Apply to Refinance Your Loan

When you've done all the prep work and found the right lender, you'll be set to submit an application for a new loan. If you get notice of approval from your lender (congrats, you did it!), make a point to review the loan details to ensure the terms haven't changed. Then you'll be ready to sign the appropriate paperwork.

4. Transition to Your New Loan

Your new lender will most likely handle the actual transition of your loan. However, you might want to confirm with your original lender that your old loan was paid off and you're no longer responsible for those monthly payments. That way, you'll have peace of mind knowing you won't miss any final payments, which could show up on your credit report.

5. Start Payments on Your New Loan

Once the transition is complete, you can start off on the right foot by making your new payments on time, which can help improve your credit. Win-win.

Get the Full Financial Picture

Now that you've navigated through the process, you know how to refinance a car loan, and you understand the pros and cons of car loan refinancing, you're ready to take the next step.

Learn About Refinancing a Car Loan at PenFed

See the features, benefits, and rates we offer our members.

Learn About Refinancing a Car Loan at PenFed

See the features, benefits, and rates we offer our members.