4 things to know before refinancing your car loan

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After taking out a loan to buy a vehicle, you might consider refinancing to help pay off that debt. If you refinance your car loan, you may get a better interest rate or change your repayment terms, which could save you money.

It’s important not to rush through the process, however. It will ultimately benefit you to do your due diligence and take the time to learn how refinancing works first.

Can you refinance a car loan?

The short answer is yes, you can refinance your car loan. If interest rates have fallen since you took out your car loan or you better credit score, then you can refinance at a lower rate. It will not only reduce your monthly car payment but also reduce the amount you pay in interest over the life of the loan.

How does car refinancing work?

When you refinance your car loan, you will contract a new loan with different conditions which will replace your initial loan. Then you will start making monthly payments on the new loan.

You can choose to refinance with your existing lender or choose a new lender after shopping around to compare fees, rates and special offers.

The lender you choose will appraise your vehicle, perform a credit check, verify your income and ask for proof of car insurance. You may need to provide recent pay stubs or W-2s from the past two years to assure the lender that you can make the monthly payments.

4 things to know before refinancing

Refinancing can make owning a car more economical, but it could also mean you end up paying more in the long run. So, before you decide to refinance, you need to know these four important things:

1. How to shop around and compare lenders

In addition to your current lender, you should compare offers from auto finance companies, online lenders, traditional banks, and credit unions. This will ensure you get the best possible rate.

Keep in mind that applying for a car loan refinance counts as a thorough investigation of your credit report, which could drop your credit score by a few points. However, if you submit all applications within a certain timeframe, they will count as one application.

The period is generally between 14 and 45 days. This limits the negative impact on your credit score and allows you to explore as many options as you want.

2. What fees you may have to pay

Some lenders include a prepayment penalty in the car loan contract for the prepayment of the debt. Be sure to check if your current loan has prepayment penalties, as this could negate any savings you will realize from refinancing.

Depending on the lender, you may also have to pay an application fee, registration fee, and/or title transfer fee. When refinancing, some states will also require you to pay to re-register your vehicle, but the cost of this fee depends on where you live.

3. The value of your car

Before contacting a lender, do your research to find out how much your current car is worth. This is usually determined by its make, model, year and mileage. Check National Automobile Dealers Association (NADA) guides or trade websites such as Consumer Reports, Edmunds, and Kelley Blue Book (KBB).

Once you know how much your current vehicle is worth, you can decide if you should refinance your loan or if it makes more sense to trade it in or sell it. The lender will also assess the value of the car before approving your refinance request. If the value is too low, you will not qualify.

4. Refinancing Requirements

Each lender has specific refinancing requirements, so ask as many questions as you can when shopping and get all the information you can before you apply. The main requirements of most lenders include:

How much you owe and your car history

Your ability to refinance will likely depend on how much you still owe on your car loan, the age of the vehicle, and the vehicle’s mileage. Some lenders will not refinance older or high mileage vehicles, and most will refuse to refinance a loan on a car with a rescue title.

Loan-to-value ratio

You should know your car loan-to-value ratio (LTV) before you apply for refinancing, as the lender will also use it to decide your eligibility and loan terms.

Indeed, your vehicle is a guarantee for the loan and its real value is often lower than what you paid. The lender may require a down payment from you to reduce the loan amount so that the amount you owe does not exceed the value of the vehicle.

Point: To calculate your LTV, divide the current loan balance by the value of the car; the resulting percentage is the LTV.

credit history

Your credit history and credit score play a key role in determining whether you are able to refinance and what your borrowing costs will be. A higher credit score makes you a less risky borrower and can help you get a lower interest rate.

Should you refinance your car loan?

Whether or not you should refinance your car loan depends on your unique situation and what it would mean for your short-term and long-term budget. But here are some scenarios where it would make sense to refinance and some it wouldn’t.

When it makes sense to refinance

  • Your credit has improved. You may qualify for a better rate if your credit score has improved significantly since you originally took out the loan. If your credit score is still below stellar, however, you can refinance use a co-signer with a strong credit history to potentially qualify for a better rate.
  • You want a lower monthly payment. If you’re struggling to keep up with paying off your debts and need some extra room in your budget, refinancing for a lower payment may be a good option. Just keep in mind that if you choose a longer term to get that lower payment, it will make you pay more interest over the life of the loan.
  • Interest rates are lower. Another reason to refinance would be if you have a high interest rate on your current car loan and interest rates are now lower.

When refinancing doesn’t make sense

  • You are upside down on your current loan. You shouldn’t refinance your car loan if you owe more on your current vehicle than it’s worth – also known as being upside down, meaning you have negative equity.
  • You will be hit with a prepayment penalty. Another reason not to is if your current lender has implemented a prepayment penalty that costs more than any potential savings.
  • You are currently applying for another loan. If you’re applying for another loan, like a mortgage, refinancing your car loan at the same time isn’t ideal. Your credit score would be negatively affected, making it difficult to get the loan, or you might be stuck with a higher interest rate.
  • You have a low balance on your current loan. If you have a low outstanding balance on your existing car loan, it doesn’t make sense to refinance. Instead, you should either pay it all off to free up space in your budget, or keep making payments to make your credit report as strong as possible.

It’s important to remember that the longer you delay paying off your loan, the more interest you’ll have to pay over time. So be sure to use a car loan calculator to see if refinancing will save you money before making your final decision.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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