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Pros and Cons of Refinancing a Car

Pros and Cons of Refinancing a Car
Sheryl Nance-Nash
Sheryl Nance-NashUpdated October 11, 2022
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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 it comes to thinking about refinancing, you likely think about your mortgage. What may not typically spring to mind for many people is refinancing their car loan, but it may be an idea worth exploring.When you refinance an auto loan, you pay off your old car loan with a new one, often from a new lender. The new loan may have better interest rates or a loan term that lets you lower your monthly payments.But, as with all things financial, it’s a good idea to weigh the advantages and disadvantages of any car refinance you're thinking about making.

The Pros of Refinancing a Car Loan

Learn how to refinance auto loans — if you decide to go in that direction. Here are some of the potential benefits.

Lower Interest Rate and/or Monthly Payments

Refinancing to a loan with more favorable terms can be a path to lowering your interest rate and/or monthly payment amount. You don’t want to make any assumptions about savings, so it’s a good idea to use an auto loan refi calculator to see if you’ll save money overall. 

Different Loan Terms

Another major plus is the opportunity to change your loan term (the time period over which you’ll be paying back the loan). Ideally, you should try to keep the term as short as you can so that you will be paying the least interest over the life of the loan. However, you’ll also want to consider your monthly budget. If extending your loan term and reducing your monthly payment helps you stay on top of your bills, adding more time may be worth it.  

You Can Afford to Pay More

Knowing when to refinance a car is critical. Refinancing can be beneficial if you can afford to be paying more per month and could therefore try to get a shorter loan term.

You Could Get Better Terms

A loan term is an agreed-upon amount of time in which you make monthly payments toward a loan. Car loan terms are in 12-month increments. The term lengths you’ll come across most often for vehicle financing are 24, 36, 48, 60, 72, and 84 months. Shorter terms often mean higher monthly payments.

You Can’t Keep Up with the Bills

If you refinance for a loan with longer terms, it usually means your monthly payments will be lowered. So you can get relief from a debt you may be struggling with.

Frees Up Money to Pay Down Debt

The age of your debt has an impact on your credit score. And refinancing can temporarily lower it a little, since it’s considered new credit. However, if you use the savings to pay off higher interest debt, reduce your utilization on your credit cards, or pay off old collections accounts that may be dragging down your score, that might potentially help your score.

A Source of Extra Cash

In some cases, you could borrow extra money through a refinance. If your car is worth more than you owe on your current loan, you might be eligible for a cash-out refinance loan. This helps you refinance your car loan and borrow extra money based on your equity in the car. That’s cash you can use to pay down higher interest debt or stash in your emergency fund. 

The Cons of Refinancing a Car Loan

For all the pluses of refinancing, it’s got downsides, too. 

Finding a Lender Can Be Tough

Will you be attractive to a lender? You may not be if one or more of the following apply.
  • Your vehicle is more than 10 years old
  • You owe less than $7,500 on your current loan
  • You owe more than $100,000 on your current loan
  • Your car has more than 100,000 miles on it
  • You drive for Lyft or Uber as your primary source of income or otherwise use your car for commercial purposes

Prepayment Penalties and Fees

Read the fine print of your existing loan contract. Does your current loan charge penalties for paying off your loan early?  Many lenders don’t, but if yours does, you’ll likely want to calculate whether those fees will cost you more than you’d save with a new loan. Plus, there could be fees charged by your new loan company, too. If it costs too much to switch your car loan to a new lender, those costs of refinancing your auto loan may cancel out the benefits, and you might be better off staying with your original loan.

Temporary Credit Score Dip

Does refinancing a car hurt your credit? Yes. Refinancing an auto loan typically lowers your credit score temporarily. This is in part due to the fact that it usually requires a hard pull credit check and also to the fact that you are replacing an older loan with a newer one. The dip could take two years to go away.

4 Tips When You’re Refinancing an Auto Loan

1. Don’t be in a hurry as you shop around for a loan

Dig deep when looking for lenders and include online auto loan lenders in your search. Avoid any lender or company that charges a fee to refinance your loan — that cost could erase any savings from the new loan. And as you assess lenders, remember it’s not only fees that are worth looking at, but also what kind of interest rates they offer and customer service. 

2. Consider applying for prequalification

This will give you a sense of what type of offers you might be able to snag. What’s involved? For starters, the lender will look at your credit and the type of vehicle you own. Typically, prequalification is a soft credit inquiry, so it won’t hurt your credit score. And while prequalification is not a guarantee, it's a good indicator of what you can expect in terms of loan approval.

3. Remember the loan-related details

If you purchased a GAP waiver policy (which pays the difference between what you owe on your car and what it’s worth at the time of an accident) with your original loan, it will not automatically carry over into a new loan. If you still want GAP coverage, explore your options for a new policy with your new loan.

4. Plan your timing

Be mindful too, if in the not-too-distant future you will begin shopping for a mortgage. You might want to delay going for a car refinance so that your credit scores are as high as they can be, upping your chances of approval, to say nothing of getting the best rates and terms.

Will Refinancing Impact My Credit Score?

Any new commitment may change your financial picture. For one thing, refinancing requires a hard credit inquiry. This means your credit score may for a time drop by as much as five points when you apply with your lender. That’s generally nothing to panic about, but it’s a good idea to be mindful of it. While you want to shop around for your loan, actually submitting multiple applications can ding your credit score down. However, timing is everything. If you submit all your applications within a 14 to 45 day window, the impact to your credit score should be the same as if you’d only submitted one application. That’s because credit score compilers understand that you may be “rate shopping.”

When Is It Worth Refinancing a Car?

When or whether to refinance is not always black and white. Much depends on your circumstances and your goals. 
  • A refi could make sense if you lost your job, or a spouse is working less and you need to cut your monthly budget.
  • A refi might be a good idea if you can qualify for a better interest rate or better terms than you got on your old loan. It could be that when you got your car loan your credit score was pretty shabby, so you didn’t get a great rate. However now that your score has improved, you’re likely eligible for a much better rate. Lowering your payment by a percentage point or two can make a difference and save you money.  
  • Refinancing might also align with your goals. For example, if you’re on a mission to pay down debt, applying the monthly savings from refinancing can help you get there.

Can You Refinance With Bad Credit?

If your credit is bad, you may be turned down. And if you are offered a loan, you may not qualify for advantageous interest rates if you are trying to refinance with bad credit. 

Alternatives to Refinancing Your Auto Loan

If you’re close to paying off your original car loan, getting a new loan may not make sense.Also, if the balance on your existing loan is higher than the value of the car, you’re upside down on your auto loan, and getting the green light from a new lender could prove to be difficult, so you might want to stay where you are.

The Takeaway

Refinancing a car can be a smart strategy — in some cases. Do the research to see if the numbers work out in your favor or whether you’re better off with your existing loan. If you’re considering refinancing, Lantern by SoFi may be able to help. Fill out one simple form and learn about refinancing an auto loan so you can find the one that’s best for you.
Photo credit: iStock/Dean Mitchell

Frequently Asked Questions

What are the advantages of refinancing a car loan?
What are the disadvantages of refinancing a car loan?
Why does my bank want me to refinance?
Does refinancing a car require a hard inquiry?
Can you refinance your auto loan after just 1 year?
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About the Author

Sheryl Nance-Nash

Sheryl Nance-Nash

Sheryl Nance-Nash is a freelance writer specializing in personal finance, business, and travel. Her work has appeared in Money Magazine, Newsday, The New York Times, Business Insider, BBC.com, AARP the Magazine, ABCNews.com, Forbes.com, among others.
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