Auto Loan 101: What is Auto Refinancing?

Disclaimer: Upstart is not a financial advisor, the following content is for informational purposes only.

Picture this: you financed a car about a year ago with a 5 percent interest rate and a monthly payment of $550. Due to life-changing events, you want to lower those monthly payments and decrease your interest rate, but don’t know where to start. 

On average, Americans owe over $1.2 trillion on auto loans, making up for approximately 10 percent of the overall consumer debt. With the unemployment rate at 5.8 percent in May 2021, many Americans are researching ways to save money where they can, including refinancing their auto loans to reduce their monthly payment. 

While auto refinancing sounds like a good idea off the bat, most people don’t exactly know what it entails or what its long-term effects are. 

What to know about auto refinancing

If you’re looking to save some money, refinancing a high-interest rate loan to a lower rate may save you money over time. 

If your monthly payments are too expensive, refinancing to an auto loan with a longer loan term will get you to lower monthly payments. However, depending on how many more months you extend your payments and add to your term, it may end up costing you more money over the life of the auto loan. Therefore, do the calculations and factor in how much longer you will be paying the loan.

Auto loan refinancing typically comes with extra fees and may temporarily cause a dip in your credit score. The bottom line, refinancing an auto loan is not always a guaranteed “money saver.”

At Upstart, we are here to help answer these crucial auto refinancing questions to ensure you’re making the most informed decision possible. In this post, we’ll explain when it may be best to consider refinancing your car and the top things to think about when considering refinancing. 

We will also outline when it may be best to hold off on refinancing your car, even when you think it may help you in the long run.

What is auto loan refinancing?

Auto refinancing involves replacing your existing car loan with a new loan at a different interest rate. These loans are secured against a car and paid off in fixed monthly payments over an extended period, typically over several years. 

When should you refinance your car?

One factor when considering an auto refinance is interest rates. Interest rates change regularly, so there’s a possibility that rates have fallen since you took out your original auto loan. Even a drop of 2 or 3 percentage points may result in significant savings over the life of your loan. 

Consider your overall finances and how it has changed from the time you first purchased your car. If your financial situation has improved, lenders can look at your debt-to-income ratio to determine if it’s in good health and at a lowered ratio deemed worthy of a lower rate. If it is, your lender is much more likely to reduce your interest rate, which will save you money over time. 

If you’re having trouble keeping up with your monthly payments because of your first auto loan, refinancing with a lower interest rate could be a good alternative. 

What items/documents may be needed for a car refinance?

To refinance your auto loan, lenders will require personal and financial documents. Here is a checklist of what you need to prepare: 

Your ID Usually a driver’s license or passport that shows your photos and information will suffice.
Proof of Income Lenders want to verify that you are low risk and will pay back the loan in a timely manner. They assess your income, assets, employment, and credit history to make that determination. Grab your pay stubs from the last few months and be prepared to show your bank statements as well. 
Financial History The lender may review the other types of credit accounts you have, when you opened them, what the balances are, and payment history. Essentially, they are looking for your debt-to-income ratio, credit history, and whether you consistently pay your bills on time or not. 
Proof of Residence If your driver’s license address isn’t your most current, you may need to provide proof of where you live, which includes: utility bills, mortgage statement, lease agreement, or bank statement. P.O. boxes are not allowed. 
Your vehicle’s information Depending on where you are financing your vehicle, you will need to provide documents to the new lender. If you financed through a dealership, the dealer should be able to provide all of the vehicle’s information. If you are working with the lender directly, you may need to obtain a complete bill of sale which includes the purchase price, VIN, and make and model, and year of the car. 

How does refinancing affect your credit score?

Refinancing will affect your credit because lenders first do a credit check when you apply for the new auto loan. They look at your credit score and history—essentially doing a hard inquiry on your credit. This can cause your credit to dip, but it’s only temporary. 

If you are approved to refinance, you could save money on your monthly payments, ideally freeing up some of your budgets each month. If you have other debt to pay, you can use that money to help pay off that debt as well as the loan for refinancing.

When shopping around for a refinance lender, make sure to do it in the specified window, usually between 14 to 45 days. For example, VantageScore 3.0 counts multiple credit inquiries within a two-week timeframe as one inquiry, while FICO scores use a 45-day window. Just to be on the safe side, it’s best to try to keep your rate shopping within 14 days. 

How much is your car worth?

It’s typically not necessary to get a car appraisal if you want to refinance. The lender should be able to look up your vehicle’s information on their own, including age, mileage, make, model, condition, and vehicle history. 

However, in the event that the lender needs this information from you, get your car’s value through online auto websites, such as Kelly Blue Book or Edmunds, which provide estimation tools for you. All you have to do is plug in your car’s information. Even if your lender doesn’t need this from you, it’s a good idea to do it on your own so you know your car’s worth and can figure out if you’re getting a good deal on the refinance, as your car’s value is a large factor in determining the rate of your auto loan. 

When should I consider holding off on refinancing my car loan?

If you’re looking to increase or maintain your credit score because you want to apply for a mortgage or get a new credit card, refinancing can negatively impact your score. You’re also more likely to incur fees like lienholder and state re-registration fees. They’re not too costly, but it’s smart to ensure these fees don’t outweigh the current fees you’re already paying for your auto loan. 

Some lenders give out prepayment penalties for paying off your current auto loan earlier than planned with your refinance loan, so you may have to pay some additional interest in addition to the principal. If you’ve already paid off most of your car loan or your car has an exorbitant amount of miles, it may be best to hold off on refinancing and continue paying off your car as normal. The longer you wait to refinance, the less you may be able to save on interest and the less desirable your car is to a lender.

What are some tips I should consider when refinancing?

If you still think it’s time to refinance, here are a few tips to consider. Make sure you fully understand how auto refinances works and know approximately how much money you can save. 

When you apply for a refinance, there are many factors a lender will consider to determine your rate, including your credit score and profile, the make, model, trim, and mileage of your car. 

Additionally, lenders will look at the value of your vehicle relative to how much you owe on the vehicle—your loan-to-value ratio—and how many payments you have left on your current auto loan to determine if refinancing is worthwhile for both parties. When debating refinancing your car, it’s important to consider how much your car has depreciated, how recent your current loan is, and your loan-to-value ratio.

Once you get your rate, you should evaluate the rate or terms offered to meet your financial goals. You should also make sure that you understand any additional fees or prepayment penalties so you can understand the total cost of the loans you’re comparing.

If all those boxes are checked off, you’re ready to take the next step toward refinancing your car. Consider auto refinancing with Upstart.

State Restriction: Product not available in IA, MD, NV, or WV. Loans in FL may be originated by Cross River Bank or Upstart Network Inc. All other loans are originated by Cross River Bank.

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