How to refinance your car loan in 7 steps

If you answered “yes!” to one or more of the above questions, refinancing your auto loan might be a smart money move. Put simply, refinancing an auto loan involves taking out a new loan to pay off your old loan and starting over with a new lender. 

If you’re ready to explore the possibility of refinancing, you probably have a new set of questions: 

• How can you determine that refinancing is right for you? 
• Do you and your car qualify for refinancing? 
• What documentation will you need to prep?
• How will refinancing affect your credit score?
• What are some common pitfalls to avoid when refinancing an auto loan? 

I’ll answer these questions and more as I explore how to refinance your car loan in seven steps. 

1. Check your credit score

Checking your credit score before taking out a loan is like checking your breath before a big date. It’s a small thing, yet it can determine the outcome of everything else. 

Your credit score will determine the overall terms of your new loan just like your old one. Put simply, high scores (700+) translate to lower interest rates. 

What’s most important, however, is whether your credit score has improved since you took out your first auto loan. If your credit score has gone from 640 to 700, refinancing almost certainly makes sense, since you’re likely to get a lower interest rate. However, if your credit score has dropped from 800 to 700, your new interest rate may even go up. 

Thankfully, like swishing with Listerine, checking your credit score only takes about 30 seconds. Visit your online banking dashboard or Credit Karma – they’ll all show you your score for free. 

If your credit score has remained steady or dropped a few points, it’s still worth taking steps two through four of this guide to at least get some rough quotes. If your score has plummeted over 100 points, that might be a sign it’s time to improve your credit score before taking on any more debt. 

2. Determine whether refinancing is the right choice

A rise in your credit score since taking out your first loan is a good sign that refinancing makes sense. However, a jump in credit score isn’t the be-all and end-all. 

What other factors should play a role in your decision to refinance your auto loan? 

What are the terms of your existing loan?

Naturally, you’ll want to get a clear picture of your existing loan terms before you start cross-shopping. What is your interest rate? Is it fixed or variable? How much of your loan amount do you still have to pay off? How many months do you have to pay it off? 

All in all, specifically what are you trying to get out of a new loan? 

Tinker around with MU30’s handy Loan Payoff Calculator and see where the weak link is in your existing loan. Most commonly, folks are trying to lower their interest rate. In addition to lower interest, you may want a slightly longer loan term to lower your monthly payments (just don’t let your total interest paid get too out of control). 

One quick note before I move on: if you got your financing directly from the dealer where you bought the car, you probably want to refinance. That’s because dealers aren’t known for offering customers the best financing deals (or even close to them). Dealers offer convenience, not savings. So it may be time to break up with your dealer/lender and find someone with a better rate. 

In addition to basic details like your interest rate, term, and loan amount, there’s another important factor buried in your loan document that most folks tend to gloss over. 

Does your lender have prepayment fees or penalties?

Perhaps the biggest “gotcha” in the refinancing world is prepayment penalties. Yep – your lender may charge you for paying off your loan too early. 

If lenders charging fees to people who, you know, pay back their loans sounds ridiculous, it actually makes perfect sense. When you sign a loan document, you promise to pay back your lender the amount you borrowed plus interest. The interest not only protects your lender’s money from inflation, but it’s also their only source of profit. 

So when you pay off your loan early, you’re withholding the interest you promised to pay. Call me a late-stage capitalist, but lenders are kinda entitled to that money. So they’ll try to recoup at least some of it in the form of prepayment penalties. 

In your case, you’ll want to revisit your loan document and search for any prepayment penalties or fees. These can often be expressed as a percentage of the principal, interest, or total loan amount remaining, or a flat fee. 

If your lender’s prepayment penalties are egregiously high, refinancing may not make sense. Either way, keep this fee in mind as we move forward. 

Are you “underwater” on your loan?

Your next step is to compare your car’s resale value to the amount you have remaining on your loan. If you owe your lender more than the car is actually worth, you’re what’s known as “underwater” on your loan. 

Why does being underwater matter if you’re not selling the car, just refinancing it? 

Well, many lenders won’t refinance a car that’s underwater. The reason being, if you default on the loan, they can’t just repo and resell the car for the amount they’re entitled to. They’re taking on risk, so they’re unlikely to give you better loan terms (or a loan offer at all). 

If you’re underwater on your loan, consider increasing your monthly payments or making a lump sum payment to get right-side-up. You can also talk to your current lenders to establish a new payment structure (because they don’t want you underwater, either). 

If you’re not underwater on your loan and you owe less than the car’s worth, let’s consider the last major factor determining your refinancing options. 

Will your car’s age and mileage disqualify it for refinancing?

Lastly, many lenders have strict age or mileage requirements for refinancing. Generally speaking, options tend to start drying up around 100,000 miles or eight model years old. Bank of America, for example, won’t refinance cars with over 125k on the odometer, while Capital One won’t touch cars over seven years old. 

Hopefully, your car is young and youthful enough to qualify for refinancing, so let’s move on to step three: gathering all the things!

3. Gather all the things

Next, you’ll want to have lots of documentation on hand to ensure a smooth and efficient loan application process. The list of essentials is longer than when you applied for your first loan since you’ll need to provide details of your car (which your previous lender might’ve already had) and, of course, details of your existing loan. 

This isn’t a comprehensive list since every lender is different, but this will cover what 80% of lenders will ask for: 

The basics

The first thing lenders will ask for is your basic personal, demographic, and background information. I’m sure you wouldn’t, but don’t tell any white lies here or anywhere else in your loan applications hoping for a better rate. 

Your lender will find out the truth when they do their own due diligence, and “discrepancies” may lead to immediate disqualification. 

Proof of income

Next, your lender will likely ask for proof of income. This will kick off a long line of questioning regarding your financial status, since your lender will want a clear picture of how much money you make and thus your ability to pay back your loan. 

For proof of income, whether you’re on a W-2 or 1099, last year’s tax return usually does the trick. You should be able to download it as a PDF from your tax software, or alternatively, you can download your tax returns directly from the IRS. 

Details of your finances

Your lender may also ask you about your other debts and regular payments, including your rent, mortgage, student loan payments, and more. Again, they’re trying to get a fix on your ability to pay off your auto loan. 

Car-related info

Next, and not too surprisingly, your lender will want details on your car. In addition to make, model, and mileage, they’ll probably want to know the Vehicle Identification Number (VIN). This is like your car’s Social Security number, and lenders can use it to track the vehicle’s accident and maintenance history. 

You can typically find your VIN on a sticker on the driver’s door. As an aside, it’s smart to have your VIN saved in your phone in case you need to file a claim, accident report, or even just when you’re looking for a better deal on auto insurance every six months. 

Proof of insurance

Speaking of insurance, your lender will also require you to provide proof of insurance when applying for a loan. 

When it comes to the relationship between auto loans and insurance, there are two things to keep in mind: 

• Your current lender may have minimum insurance requirements that exceed your state liability minimums. Before applying for a new loan, you’ll want to make 100% sure that you’re meeting your current lender’s requirements. If you’re not, your new lender may notice and disqualify you.
  
• Your new lender may have higher insurance requirements than your old lender. It’s not a common occurrence, but it happens. For example, your current lender may only require liability insurance, while your new lender requires collision and comprehensive on top of it. Considering the latter two cost around $800 extra per year, refinancing with that lender may not make sense. 

Related: The Best Car Insurance Companies For Young Adults

Details of your existing loan

Lastly, your new lender may want to hear details about your relationship with your current lender. They may ask about your existing interest rate, your loan amount remaining, and other terms. 

Now, your new lender also may not ask about this stuff at all. It could be because they don’t care, or it could be because they plan to look it up themselves. 

Either way, however, you might as well gather this info for your own benefit. Having your interest rate, remaining loan amount, prepayment penalties, and other key details on hand will help you cross-shop, do fast math, and ensure you’re getting a better deal on a refinance. 

Once you have all the things ready, it’s time to start window shopping. 

4. Get some early quotes and ballpark figures

Thankfully, before you submit full loan applications (and trigger hard credit checks), you can “window shop” for loans on many lenders’ websites. 

Monevo is an aggregator like Kayak.com. Key in some details on your loan, credit score, personal info, address, employment, and more, and Monevo will show you multiple competing offers from reputable lenders – all without making a hard credit check. 

Keep in mind that without a hard credit check, none of the early quotes you get from step four will be 100% accurate. But hopefully, having a range will at least empower you to handpick the three-five best lenders to complete a full application with. 

Related: Auto Financing For Smart People: Tips For Saving On Your Car Loan

5. Start applying

Once you’ve compiled a list of a few reputable lenders with good terms and promising interest rates, it’s time to start the formal application process with each of them. 

Keep in mind, however, that this process will take time and result in a hard credit pull dinging your credit a bit. So it pays to be prepared and to make sure you’re 100% ready for step five. 

So before you take the plunge, run through a quick mental checklist:

• Has your credit score improved since your first loan (or should you improve it a bit, first)? 
• Have you determined that auto refinancing is the right move (i.e. your existing terms could be better, your lender’s prepayment penalties aren’t too high, etc.)? 
• Do you have all the necessary info and documentation on hand to ensure a smooth application process?
• Do you have a curated list of three-five lenders you’re ready to apply to?
• Do you have enough time in the next 14 days to apply to each lender on your list, ensuring there’s only a single hard pull of your credit?

If so, it’s time to start applying and getting some tailored quotes!

Remember when you’re cross-shopping to compare every term of the new quote to your existing loan terms. If a new loan offer seems like a better deal than your current one, do the math to confirm your gut feeling.

Lastly, be sure to carefully read through the whole loan agreement for any loan offer you’re considering – look for fees and prepayment penalties, and don’t hesitate to reach out to your potential lender with questions. 

When you feel comfortable and confident that you’ve found a winner, congrats! Go ahead and accept your loan offer. Just two steps left. 

6. Pay off your old loan

Your next step is to ensure that your old loan is fully paid off with your new one. 

Honestly, there’s no better way to achieve this than to simply reach out to your two lenders to ask how they’d like to handle the payoff. 

These days, it’s common for lenders to pay each other directly. This is a great option for you since it removes a step and absolves you of any transaction-related fees that might arise if you were the payor. 

Now, before ending payments on your old loan, you’ll want to get super, ultra, 100% written confirmation that your old loan is fully paid off. The reason being, you don’t want to botch the landing, miss a payment, and ding your credit score. Pester your lenders via online chat if you have to, but make sure that the old loan is paid off!

Once your old loan is paid off, let’s tie a bow around this whole process with what may be the quickest, yet most important step of all. 

7. Set up automatic payments on your new loan

Forgetting to set up automatic payments on a loan is like forgetting to set the timer on the oven – something’s gonna get burnt, whether it’s your leftover Mellow Mushroom or your credit score. 

Virtually all lenders these days have an option to set up automatic payments. That’s because they’re heavily incentivized to – autopay means fewer missed payments, which means more revenue, which means lower rates and more clients. 

Autopay is like catnip to lenders – so much so that many will even pay you to set it up. 

That being said, perhaps you’re nervous about setting up autopay because it runs the risk of overdrawing your checking account. Indeed, overdrafts are no fun because they often incur $15 fees and such. 

But consider this: overdrafts on checking accounts don’t directly affect your credit score. Missing payments on your auto loan will.

To me, it’s better to pay a one-time, $15 overdraft fee than to let a missed payment mar your credit history – especially since that ding could affect your mortgage rates in a few years. Plus, your bank might reverse your overdraft fees if you quickly replete your account – but TransUnion won’t forgive a ding to your credit no matter how nicely you ask.