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How Does Refinancing a Car Work? 7 Steps

man signing documents of car loan

To understand what refinancing is all about, you first have to comprehend the essence of a car loan. Simply put, it’s a secured loan offered to prospective automobile buyers, whenever they feel ready to finance a second-hand or brand-new car. In other words, the ultimate goal of a car loan is similar to that of every other loan—and that is to help the borrower finance a purchase.

Once you’ve secured the loan, you’ll eventually have to pay it back. But paying back the loan might be difficult depending on your situation, thus forcing you to apply for a second loan to pay off the existing one. Ideally, the second loan will have much better terms, seeing as the goal is to help you settle your main debt. That’s what refinancing is all about.

If you successfully refinance your car, you’ll end up saving money. This could be through the reduction of the interest rate or payment period. But that’s just a brief rundown of what refinancing is.

Read on below to find out more:


car and road divider

The 7 Steps of the Process of Refinancing a Car

Refinancing a car is a process, and it all starts with the reasons why you feel the urge to refinance the loan. So, before you even pick up the call to reach out to your lender, ask yourself if you have the ability to refinance your car loan.

1. Figuring Out If Refinancing Is Even an Option

Replacing the current auto loan might not be a walk in the park for everybody.

It’s virtually impossible for some loanees if one or all of the following factors apply to them:
  • Owning a high-mileage car: We have a good number of lenders who prefer steering clear of cars that have a high mileage or those regarded as old. So, if you’re hoping to secure a new loan, you’ll have to first find a way to upgrade your car.
  • The remaining balance is more than the car’s value: Convincing the lender to offer some favorable terms will be an uphill climb if the value of the car is lower than the balance you owe. It’s important to remember that lenders are in the business to mitigate risks while making a profit. After hearing you out, they’ll find your proposal too risky and less profitable.
  • An existing prepayment penalty: Paying off a significant chunk of the loan too early is not always a good idea. You’ll have to cater to some prepayment penalties and also deal with the possibility of canceling out any refinancing opportunity that you previously had.
  • Late payments: Being late with your payments is a sign that you’re a high-risk borrower. No lender likes to work with such a person, and that’s why your chances of qualifying for a better loan will be low.
female signing car insurance document
Image Credit: Opat Suvi, Shutterstock

2. Assessing Your Credit Situation

Checking your credit score should be your next step. Even though ranges usually vary—as they are often contingent on the applied credit scoring model—a fair credit score ranges from 580 to 669.

But “fair” won’t be ideal in this case, if you want to easily qualify for a loan that’s complemented by a lower interest rate. You’ll need a score that’s considered “good,” “very good,” or “excellent.” That’s 670–739, 740–799, and above 800, respectively.

By the way, if your score falls under the “very good” category, but hasn’t improved since securing the loan, finding a better interest rate won’t be easy. If it was considered “fair” when you first applied for the loan, but now it’s moved up to “good”, they’ll want to work with you.

It’s wise to also take a quick look at the national average interest rates, just to gauge where things stand since the last time you signed such an agreement.

3. Shop Around & Compare Rates

The process of refinancing an auto loan is more or less the same as that of applying for a conventional loan. Don’t just talk to one lender. Applying with multiple lenders is the way to go as this gives you the opportunity to compare their terms and settle for a better option—one that’s best suited for your specific situation, seeing as borrowers have different needs.

We understand if you’re apprehensive about submitting multiple loan applications in the same period, given these types of applications normally pop up as hard inquiries on our credit report.

But you shouldn’t worry, because the main reporting agencies like to treat multiple applications as one inquiry if they were submitted at the same time. That’s to say, they already know that some borrowers like to scout lenders, to increase their chances of getting favorable deals.

couple at the car dealer showroom
Image Credit: Nejron Photo, Shutterstck

4. Have the Relevant Documents Ready

Organization is a sign of preparedness. And you have to be mentally prepared for the arduous task ahead.

From our experience, the following documents are standard for every loan applicant:
  • Social security number
  • Proof of income
  • Proof of insurance
  • Driver’s license

They’ll also ask for a copy of the original loan agreement. So, if you can’t remember where you placed it, or if you can’t get to it for some reason, you’ll have to ask your lender to send you their copy.

While looking at the existing loan, the new lender will be curious to know:
  • Your car information i.e., the VIN
  • The loan’s interest rate
  • Number of months left to completely pay off the loan
  • Monthly installments
  • Remaining balance

5. Ask Questions

Don’t sign any dotted line before getting answers to all your questions. Have an attorney to help you interpret the fine print and cover all your bases. If you sense the lender is hesitant to answer questions such as “Are there any early payoff penalties or origination fees?”, they are definitely hiding something, so you shouldn’t be working with them. You can easily be trapped in yet another debt that will sink you deeper.

car salesman talking to a couple at the dealership
Image Credit: Antoni Shkraba, Pexels

6. Get Pre-qualified

You’ll want to immediately sign that deal if you’re confident that you’ve qualified. But that’s a rookie mistake, one that might land you in hot soup down the road. A knowledgeable borrower will first go for pre-qualification, as that will eliminate the risk of having to deal with a hard inquiry on his/her/their credit report, should things not go their way.

7. Apply for the Auto Refinance Loan

At this point, you shouldn’t be having any doubts. Everything should be on track and the only step left is the actual application. Currently, you don’t have to show up in person, if you have other engagements. You could do it online or over the phone. Just don’t forget to review the terms one last time to be sure you didn’t miss something.

When your loan’s ready, you’ll either receive a check or a notification that the new lender has already settled the old debt.

car dealership
Image Credit: 4 PM production, Shutterstock

car and road divider

The 4 Advantages of Refinancing a Car

1. Fewer Interest Payments

Qualifying for refinancing means they went through your financials and felt you weren’t a credit risk. A borrower is often regarded as a credit risk if he/she has the potential of failing to meet their loan obligation, as per the terms of the agreement. Although you’ll be applying for a second loan, the lender will still try to maintain your improved credit score. And one way of doing that is by giving you a facility that earns a lower interest rate.

2. Reduced Monthly Payments

If the previous loan had monthly installments that were unsustainable, refinancing could act as a reprieve that you so desperately yearn for. Reduced monthly payments will help you get through those tough financial times or pay off any other higher-rate debts that are giving you migraines.

To be clear, the lower refinancing interest rates will certainly reduce your monthly installments to a degree. If you intend to significantly reduce them, you’ll have to extend the loan term. The only downside about this move is that you’ll end up paying more interest in the long haul.

Two people going over insurance details
Image By: Jumpstory

3. Repaying the Current Loan on Time

Let’s say you just got a promotion at work so you’re expecting a salary increase. You realize that your primary source of income might still not be enough to pay off the auto loan, but it can help you secure a refinancing auto loan. Of course, you could always choose to pay extra instead of taking the refinancing route, but ask yourself; are those early repayment penalties really worth it?

4. Leveraging the Automobile’s Equity

If accessing hard cash is the problem you could easily borrow using your car’s equity. Depending on the make and model, your car’s equity will be its value minus the amount you owe the lender. For example, if the vehicle’s current valuation is at $30,000, and you owe a debt of $15,000, you could apply for an auto loan of $20,000, pay off the old loan, and take the remaining $5,000 in cash.

We like to call this option “cash-out refinancing” and it’s not usually available to everybody. Also, like every other loan, it has its own limitations. We normally advise borrowers to consider taking this route in cases of emergencies seeing as it could push you into financial trouble.

car and road divider

The 2 Disadvantages of Refinancing a Car

1. Paying Higher Interest Rates

You shouldn’t even be thinking about refinancing a car if your credit score is terrible. You might be lucky to find a lender who’s willing to roll the dice on you, but the costs are going to be astronomically high. Especially if the loan is meant to be paid in the long term.

woman hand with money
Image By: SOUTHERNTraveler, Shutterstock

2. Bankruptcy

We’ve seen people be in worse positions financially go for refinancing, and then end up in the worst position. It’s almost like borrowers sometimes forget that refinancing is also a type of loan that comes with a set of obligations that have to be met.

Have you ever heard of the upside-down car loan? It’s a phrase used by financial experts to describe a situation whereby the loan is more than the vehicle’s value. A $20,000 loan taken on a car that’s worth $15,000 is a great example of what an upside-down loan is.

car and road divider Frequently Asked Questions (FAQs)

Is It Possible to Refinance a Vehicle with the Same Lender?

Yes, even though not all lenders are comfortable refinancing an existing car loan with the same client, most of them are. But before they do, they’ll try to convince you to consider a loan modification. It’s different from refinancing in that they only get to change the original terms of the current loan.

What’s the Alternative If You Can’t Secure a Refinance Auto Loan?

First off, ask the lender if they are willing to renegotiate the terms of the agreement. Lenders are not robots, so they understand that situations change with time. If they are not open to renegotiations, you could always sell the car and pay off the remaining balance.

car salesman holding a key with car insurance or warranty
Image By: kan_chana, Shutterstock

When Is Refinancing an Auto Loan a Bad Idea?

Refinancing a car loan isn’t a good idea if you have a large purchase coming up. You also shouldn’t think about it if the original fees and prepayment penalties will severely dent your bank accounts. Only refinance the loan if the savings earned through it outweigh all the other costs.

car and road divider


“Should I consider refinancing my auto loan?” is not the question that you should be asking. Instead, ask yourself if lenders will want to work with you, taking into consideration your credit score, the state of the vehicle, the value of the car, and your current loan balance. Only apply for the loan if you feel like it’s the best way to improve your financial status.

Featured Image Credit: gpointstudio, Shutterstock


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