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How Does Car Refinancing Work?

Finance | 11/16/2021 23:00

The word refinancing is thrown around all the time these days. From mortgage refinancing to student loan refinancing, everyone is buzzing with talks of low interest rates. But what exactly is refinancing, and how does car refinancing work? 

In this article we discuss what refinancing is, how car refinancing works, and discuss how it may be beneficial for you to do right now.

What is a Car Loan?

A car loan is a secured loan that can help you finance a new or used car. A car loan works in a similar way to other types of loans. A financial institution will pay for your car and you will repay them in monthly installments with an additional fee (interest). Your car acts as collateral and, if for any reason you cannot repay the lender, your car will be taken away. It's because these loans have this collateral that they're considered "secured."

What is Refinancing?

Simply put, refinancing is paying off an existing loan with a new loan, ideally a loan that has better terms. Refinancing a car to better terms often results in saving money, either in the long run by reducing the payment period or interest rate, or in the short term by reducing monthly payments.

What are the Benefits of Refinancing?

Save Money with a Lower Interest Rate 

You may be able to secure a lower interest rate, either because of the current economic climate, or because your own personal financial situation has improved. This is the primary motivator for people to refinance. By lowering your interest rate, you are lowering your monthly payments and will end up saving money over the course of the loan.

Save Money with a Shorter Payment Period 

When you refinance, you may be able to change the terms of your payment period and shorten the period. This can save you money overall, as the sooner you pay back the loan, the less interest you will ultimately pay.

Reduce Your Monthly Payments with a Longer Payment Period 

If money is a bit tight for one reason or another, car refinancing may allow you to lengthen your payment period. This will allow you to pay off the loan over a longer amount of time, reducing your monthly payments significantly. You will end up paying a bit more over the length of the loan because you will be paying interest for a longer period of time, but it can give you breathing room if you need it.

When Should You Refinance?

When Interest Rates Are Low

Refinancing is all about striking when the iron is hot. And by that we mean when the interest rates are hot. Interest rates are adjusted based on how the economy is performing. If the economy is not performing well, or is anticipated to not perform well, banks will lower their interest rates to encourage spending. If interest rates are lower than when you first took out your auto loan, it may be a good time to consider refinancing. Rates are currently very low, so there is a good chance you can get a lower APR now than you could previously.

When Your Credit Score Has Improved

Interest rates are largely dependent on the finances of the applicant. Your credit score is one of the most important factors in securing an auto loan with good terms. Credit scores are generally categorized by the below parameters:

  • 800 to 850: Excellent credit

  • 740 to 799: Very good credit

  • 670 to 739: Good credit

  • 580 to 669: Fair credit

  • 300 to 579: Poor credit

If your score has increased from good to very good (670 to 740), or from very good to excellent (740 to 800), it could be a great time to consider refinancing. The most favorable rates and terms are given to those with very good and excellent credit. Even if your score has increased within your bracket, but you haven’t crossed into a better category, it still might be worth getting a few quotes to see if you can get a better rate. 

When Your Income Has Decreased or Your Expenses Have Increased

If money is tight due to a loss of income or an increase in other monthly expenses, refinancing might be a good option to give your wallet some breathing room. If you can lengthen your payment period, you can pay off the loan over a longer amount of time, reducing your monthly payments significantly. 

When Should You Hold Off On Refinancing?

When Your Existing Loan Has Prepayment Penalties

Some loans build in prepayment penalties to offset the lost interest that comes with paying a loan off early. These penalties can be quite high, so it is important to read the terms of your loan and decide if the savings from refinancing will outweigh the fees from prepayment. If you are unsure, call your lender directly to find out how much it will cost.

When You Need a High Credit Score for Another Application

Whenever you apply for a loan or credit card there is a credit check, and hard credit checks (as opposed to soft checks) and new lines of credit can negatively affect your credit score for about a year.

This is because how new your credit is affects your score – but, as long as you maintain a good history of paying on time, this new credit will actually help your score in the long run. And, fortunately, there's a fourteen day window allowed by the big three credit bureaus that allows for all credit inquiries in that span to count as one credit hit.

All that said, if you're applying for a mortgage or starting a new lease, it might be wise to wait until after that is settled to refinance your vehicle.

When The Timing of Your Loan Isn’t Right

While you can technically refinance at any time during the life of your loan, there are certain times where it will not make sense or be beneficial to refinance. 

  • You’ve had your existing loan for less than six months. It takes some time for your credit score to bounce back after taking out a loan, so waiting at least six months will be helpful if you hope to get a better interest rate than before. If this is your first loan, it is recommended to wait at least a year to prove that you have a history of on time payments.

  • You have less than two years left on your loan. Car loans accrue interest over time. Because of amortization, your earlier payments pay off more interest than your later payments. As you near the end of your loan, you are paying less and less on interest and more and more on principle. The longer you wait to refinance, the less beneficial it will be to do so.

How Do You Refinance a Car?

If it seems like car refinancing might be a good idea for you, let’s go over how to start the process of refinancing. It's a hassle-free process (especially when you use Auto Approve!) and can save you money in the short and long term.

Do Your Research

Make sure you are as prepared as possible. Request a credit report, which you can do once per year for free, and make sure your credit score is good. Check that everything is accurate on your report. You can petition the credit bureau if there are any inconsistencies or errors. Look at your current loan contract and make sure you are aware of any penalties for which you may be responsible. Call your lender directly if you have any questions or want to review any of the fine print.

Apply to a Few Different Lenders

The application process is similar to your original car loan application. You will need the following to get started:

  • A Photo ID, such as a passport or driver’s license.

  • Your vehicle’s information, which may include the bill of sale, VIN number, make, model, and year of your car.

  • Proof of income and financial history, which may include pay stubs, banking information, and your credit report.  

  • Proof of residence, such as a mortgage statement, lease agreement, or utility bill. Note that PO boxes are not acceptable as proof of residence.

  • Proof of insurance. 

Compare Rates 

After all of your applications are submitted, you should start hearing back with different car loan APRs and terms. Compare all of your offers and choose the one that gives you the best rate and makes the most sense for your personal situation. When you use Auto Approve for this process, one of our agents will talk you through the best options and help make sure you understand your new contract completely. (Oh, and when you refinance with Auto Approve, there are no mark-ups, so you're actually getting the best rate available every time!)

Sign and Start Saving Money

Once you have picked the best car refinancing option, sign on the dotted line and start seeing the benefits of refinancing immediately.

Refinancing your car loan is a simple process that can save you a boatload of money.

Auto Approve can make this process even easier and simpler for you! Just fill out some basic information and we can help you start comparing rates today. We never mark up your rates, because we're passionate about passing the savings right on to you. So if you're thinking, “Boy howdy, I better get to refinancing now!,” contact us today, Cowboy! (Seriously, what are you waiting for?)


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*APR and Fees Disclosure: Auto Approve works to find you the best Annual Percentage Rate (APR), which is based on factors like your credit history, vehicle and desired payment terms. Fees to complete your loan refinance vary by state and lender; they generally include admin fees, doc fees, DMV and title. Advertised 6.24% APR based on: 2019 model year or newer vehicle, 730 minimum FICO credit score, and loan term up to 72 months. All loans subject to credit and lender approval.
Auto Approve has an A+ rating with the BBB and is located at 2860 Vicksburg Lane North Plymouth, MN 55447. Auto Approve works to find its customers the best terms and APR, which are based on factors like credit history, vehicle, and desired payment terms. Loan amounts, costs, and fees vary by state and lender; they generally include admin fees, doc fees, DMV, and title fees, depending on the lender and period of repayment. There is no fee to obtain a quote and all refinancing-related costs are included in the amount financed so there are no out-of-pocket costs! For more information, please go to AutoApprove.com.