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How Does Car Refinancing Work?

How Does Car Refinancing Work?
Austin Kilham
Austin KilhamUpdated September 11, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
When you refinance your auto loan, you take out a new loan — preferably one with a lower interest rate or better terms — and use it to pay off your old loan. You then make payments on the new loan. Ideally, in swapping one loan for another, you are able to save money or make your monthly payment more manageable. Here’s a look at how refinancing an auto loan works, the benefits of refinancing, and the steps you should take if you’re considering one. 

What Does Car Refinancing Do?

The refinancing process can help you lock in a lower interest rate or it can help you change your monthly payment by shortening or lengthening your loan term. If your goal is to lower your monthly payment, you’ll need to lengthen your loan term. Be aware that a longer term means you’ll end up making interest payments for longer, which can ultimately increase the cost of your loan. When you shorten your term, you increase your monthly payment, but you decrease the length of time over which you’ll pay interest. This can help make your loan less expensive overall. 

Why Should I Refinance My Auto Loan?

Two of the main reasons for refinancing your car are to help you lower your interest rate or change the size of your monthly payment. Interest rates are based in part on a lender’s prime rate. The prime rate is based on the federal funds rate, which is the amount of interest banks charge each other to borrow overnight. When the Federal Reserve lowers interest rates, loan rates may drop, as well, signaling a potential opportunity to refinance your car. The interest rate a lender offers will also be based largely on your credit score. The better your score, the lower your interest rate will likely be. If your credit score has improved recently, you may consider refinancing. Finally, if you want to pay off your loan faster or you’re looking to make your monthly payment more manageable, consider refinancing to change the length of your loan term.Recommended: When Should or Shouldn’t You Refinance a Car Loan?

How to Refinance a Car

If you’re interested in switching out your old loan with a new one, here are the basic steps you’ll need to follow on how to refinance your auto loan. 

1. Determine Whether Refinancing Makes Sense for You

If you qualify for a lower interest rate or you’re looking to change your loan terms, a refinance might be right for you. However, there are certain situations in which it may not make sense. For example, find out if your old loan has prepayment penalties. If it does, these penalties could negate whatever money you might save on a refinance. If you owe more money than your vehicle is currently worth — a situation known as being underwater on your loan — you may have trouble finding a lender willing to extend a new loan. In this case, you may consider continuing to pay off your old loan until you are no longer underwater. 

2. Review Your Credit Score

A higher credit score can help you qualify for a loan with a lower interest rate. If your credit score has fallen since you applied for your first loan, you may want to take steps to build it, including making on-time debt payments and paying down debt to improve your credit utilization ratio. Your credit score is based on your credit report. Check your credit report to make sure the information recorded is accurate. Report any mistakes to the credit reporting bureaus — TransUnion®, Experian®, and Equifax®. 

3. Gather the Appropriate Documents

As you prepare to apply for a new loan, prepare your supporting documentation. Lenders will usually ask for your driver’s license, Social Security number, proof of insurance, and proof of income. Your lender will also ask you for a copy of your loan contract and ask about details of your existing loan. They will want to know your remaining loan balance, your interest rate, your loan term, and your current monthly payment. Recommended: What Questions Should You Ask When Refinancing a Car Loan?

4. Apply for Financing

Once you have all of your documentation prepared, it’s time to apply for financing. Applying for a loan will trigger what is known as a “hard inquiry” or “hard pull” on your credit report. This will cause your credit score to dip temporarily. If you’re unsure about whether or not you want to refinance, you can get prequalified. Getting prequalified can give you an idea about whether you’ll qualify and what interest rates you’ll qualify for if you do decide to apply. Prequalifying also does not trigger a hard pull on your credit. 

Will Shopping Around for Rates Hurt Your Credit Score?

The credit scoring companies don’t want to penalize consumers for shopping around for the best auto loans. As a result, if you apply for multiple loans within a 14- to 45-day period (the length of time depends on the scoring company), each hard pull on your credit score will only count as one. 

How Long Does an Auto Refinance Take?

The auto loan refinancing process typically takes anywhere from two weeks to 15 business days. The process may take longer, depending on how long it takes your previous lender to apply money from your new loan to pay off your old one. Recommended: How Soon Can You Refinance a Car Loan After Purchase?

What Should You Do If You Can’t Refinance Your Auto Loan?

If you are unable to qualify for an auto loan refinance, you may want to consider the following options:

Renegotiate Your Loan Terms

If you’re having trouble making your current monthly payment, your lender may allow you to pause payments for a short period of time. They might also be willing to renegotiate your loan terms if you explain your financial situation to them. 

Sell Your Car

If you can no longer make your monthly auto payment, you could consider selling your car. You can use the proceeds from the sale to pay off your loan. If you owe more than you’re able to get for your car, you’ll need to find another source of cash to make up the difference. 

Voluntary Repossession

If you’ve missed auto loan payments and you’re in default on your loan, you could initiate the repossession process through voluntary repossession. The voluntary surrender of your car involves returning it to your lender and asking them to repossess and sell your car to partially or fully eliminate your debt. 

The Takeaway

Refinancing your auto loan can be a great way to make your monthly payment work better for you or to save money on interest, especially if interest rates have dropped or your financial situation has improved. If you’re ready to explore refinancing, shop around to secure the best terms and interest rates available. Lantern by SoFi helps you compare terms and rates from top lenders and apply in one convenient place.

Frequently Asked Questions

Can I refinance my leased car?
Can I refinance a used car loan?
How much equity do I need to refinance my car?
How do I find the best car refinancing rates?
Photo credit: iStock/Milko
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About the Author

Austin Kilham

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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