Auto Refinance 101

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Refinancing an auto loan can replace a bad or okay loan with one that’s better.

As a responsible adult, your finances are likely in a better place today than they were when you first financed your current car. Wouldn’t it make sense for your current auto loan to take your new and improved financial health into account?

Enter auto refinance loans. Refinancing a car loan pays off your old loan to replace it with a new one. Done right, and at the right time, you can replace your old loan with one that offers better terms, a lower rate and APR, and more savings.

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What is a Car Refinance Loan?

A car refinance loan is a replacement of an existing auto loan. During a refinance, a new lender pays off your current loan and provides you with a new one, complete with a different interest rate, term, and monthly repayment.

The intent of refinancing is to exchange a loan with a given interest rate and terms in exchange for one that is more favorable to you. For example, if you financed your car without shopping around, such as taking out a loan offered by your dealership, a refinanced auto loan may offer you better terms and a lower interest rate.

Refinancing can also be done when there have been significant positive changes to your credit. If you’ve worked hard to improve your credit score and strength, you should be rewarded for posing less of a risk to lenders. That reward translates to qualifying for refinance loans with more favorable terms than the initial loan you took out.

Auto refinance loans are a form of secured loan and use your car as collateral. This means that, in the event of nonpayment, your lender will repossess and resell your car to recoup the loss incurred by defaulting on your loan.

Who is Auto Refinancing For?

When you finance a car purchase, numerous factors influence its interest rate, payment term, and your monthly bill. You may not have shopped around before signing on the dotted line, or maybe you weren’t earning as much as you are now.

Your income, credit, and the world as a whole play a role in determining the specific details of a loan. When these factors change, so, too, does your ability to qualify for a more favorable loan. Refinancing an auto loan makes sense if you’ve improved your credit score, earned a promotion at work, or simply want to take advantage of reduced market interest rates.

If significant improvements have been made to your financial situation, refinancing a car loan can give you a loan with a shorter term, lower interest rate, and better savings than sticking with the loan you first took out.

In addition to potentially decreasing the interest you pay on a car loan, refinancing can also help you replace a subprime loan, get away from a lender you’re unhappy with, or add or remove a cosigner.

When to refinance your car loan

It’s generally a good idea to refinance sooner rather than later because car loan interest is amortized, or front-loaded. Refinancing early into a loan’s term will also limit the possibility of the loan being made upside down by depreciation (more on that below).

When you shouldn’t refinance an auto loan

For all its benefits, refinancing isn’t for everyone. After all, refinancing a loan isn’t a magical fix to save a few bucks — it only works if you’ve put in enough effort over time to improve your financial strength since taking out the original loan.

You should avoid refinancing if:

  • Your credit score hasn’t increased — or has worsened — since you took out your original loan,
  • The current loan is heavily upside down,
  • Refinance fees and prepayment penalties outweigh any potential savings,
  • Your current loan is almost paid off, or
  • You plan on applying for other types of credit or loans soon.

Before considering a refinance, check your credit report and consider recent changes to your finances. If you’ve been paying bills on-time, decreasing your debt, improving your credit, and earning more, it may make sense to refinance.

If you’re not there just yet, don’t fret — stay focused on improving your finances until you’re more likely to qualify for a loan refinance that makes sense.

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How to Qualify for Car Loan Refinancing

Refinancing your car loan needs to make sense for a would-be lender almost as much as it makes sense for you. Lenders look at a variety of factors to determine if you qualify for a loan refinance.

In addition to your credit history, a lender takes into account the following:

Loan-to-value ratio

Loan-to-value, or LTV, ratio represents the value of a car vs. how much you owe on the loan. The calculation is expressed as a percentage — an LTV of 100% means the loan and car value are equal. The lower your loan’s LTV, the more likely you’ll qualify for a refinance loan because you present less risk to the new lender.

You have an upside-down loan if you owe more than your car’s worth. Purchasing a new car without a downpayment or trade-in, rolling an existing loan into a new loan, or loans with too long a term can create situations in which your loan’s upside down, or underwater.

You may also be faced with an upside-down loan and high LTV due to depreciation — how much value your car loses after driving it off the lot and from wear-and-tear, age, and other factors. According to CarFax, you can expect your car to lose 20% of its value in your first year of ownership, then about 10% for each following year.

In general, an LTV ratio over 125% will make it more difficult — but not impossible — to qualify for a car refinance loan.  For perspective, 90% of approved applicants between 2015 and 2019 had a loan-to-value ratio of 123% or less, according to RateGenius data. 

If your LTV is over 125%, you may be required to have a higher credit score to qualify, or you may be offered a loan with a higher interest rate than if your LTV was below 125%.

Debt-to-income ratio

Your debt-to-income, or DTI, ratio is a calculation that compares your total monthly debt payments to your gross monthly income. In other words, is your income sufficient to responsibly meet your debt obligations?

For auto refinancing, lenders tend to be more forgiving when it comes to DTI. It’s common for lenders to have a maximum debt-to-income ratio of 50%. Some lenders don’t have a max. DTI at all.

An analysis of RateGenius data from 2015 to 2019 found that 90% of approved applicants had a debt-to-income ratio of 48% or below.

If your DTI is higher than 50%, try reducing your debt or increasing your income to increase your chances of getting approved for an auto refinance loan.

48% DTI

From 2015 to 2019, 90% of approved auto refinance loan applicants had a DTI of less than 48%.

Auto loan amount

Before it makes sense to offer you a refinanced loan, lenders may require your existing loan balance to be within a certain range. For example, lenders in the RateGenius network require an auto loan balance between $10,000 and $55,000 to qualify for refinancing.

Vehicle age and use

Due to depreciation, wear-and-tear, and mileage, loans for cars over 12 years old or with over 125,000 miles aren’t likely to qualify for refinancing.

Usually, cars must be used for personal use in order to qualify for a refinanced loan, though some lenders are willing to make exceptions.

What to Expect During the Refinancing Process

Applying for auto loan refinancing follows a similar process as applying for any other type of loan. Even if you’re a loan application pro, preparing yourself and your paperwork before starting the application can lead to shorter wait times, increased likelihood of approval, and better savings.

Step 1: Find a lender

As with any major financial decision, shop around to compare quotes and offers. There are pros and cons to each type of lender you can apply to, so make sure to perform a broad search and weigh your options before deciding on the best lender for you.

Together, banks and credit unions hold the lion’s share of new and used car loans, but there are other options.

Brokers like RateGenius work to find you the best offers available through their networks of lenders. Using a broker can broaden your search horizon and deliver a more personalized shopping and comparison experience than you may find from a direct lender.

You may also conduct your search through a marketplace where lenders compete with one another for a chance to win your business. In doing so, you’ll work directly with the lenders, though the process may require more of your time and involvement.

Step 2: Gather documents and paperwork

Lenders require some documents and paperwork before they can begin processing your loan. Before you put your application in, make sure you’ve collected:

  • Personally identifying information, or PII, such as your Social Security number and driver’s license number;
  • Proof of income and employment status or history;
  • Your cosigner or co-borrower’s information;
  • Your vehicle’s title and VIN; and
  • Information about your current loan.

Step 3: Get pre-qualified

Before applying to refinance your car loan, obtain a pre-qualified offer. During prequalification, a lender performs a soft credit check to approximate the strength of your credit and your likelihood of repaying any loan they may consider offering you.

Because pre-qualification isn’t an actual loan application, there’s no hit to your credit score.

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Step 4: Apply

Applying for an auto refinance loan will impact your credit score. Fortunately, your credit score won’t be penalized for rate-shopping since multiple credit checks conducted in the same timeframe and for the same purpose tend to count as a single credit inquiry.

So long as you provided accurate information, you’re likely to get a decision within 24 to 48 hours, at least if you applied through RateGenius. In some cases, however, decisions may take upwards of three days, and may vary even more depending on the company or companies you’re applying through.

Step 5: Evaluate your offers

Once you’ve received loan approvals, determine which is best for you and your situation. Start by comparing your loan offers on a like-to-like basis. For example, make sure you compare one loan’s APR to another’s APR, not its interest rate vs. APR.

Which loans meet your initial goals of refinancing your auto loan? If you want lower monthly payments at the cost of extending the loan term, one given loan may edge out another. Similarly, a low-interest loan with a short repayment term makes sense if you’re aiming to pay less in interest than you would with your original high-interest rate loan.

Refinancing Your Auto Loan

Many car buyers take out car loans to finance the purchase of a new or used car. Fortunately, you’re not locked into keeping the initial loan until it’s paid off. Refinancing an auto loan can save you money on interest and help you pay it off faster if you shop around for better rates and continue to improve your credit.

Consider loan offers from banks and credit unions, loan marketplaces, and brokers like RateGenius to find better terms and keep more of your hard-earned money where you want it most: in your pocket.

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