A record 107 million Americans have auto loan debt, and it’s no wonder. For many people, a car is a necessity to commute to work or pick up their kids from school.
But if your credit score was low when you bought your car, your loan’s interest rate can be sky-high. In fact, interest rates for subprime loans — that is, loans for those with a spotty credit history — can be upwards of 30%.
You could end up paying thousands more than the car’s worth thanks to interest. However, if you have a steady job and have improved your credit since you bought your car, you could improve your situation.
If you decide to refinance an auto loan, you could save thousands over the length of your loan, pay off your debt faster, or reduce your payments. Here’s how it works.
How refinancing a car works
When you refinance a car loan, you work with a different lender to take out a new loan for the amount you owe on the car.
The new lender often offers completely different loan terms, possibly including a different interest rate, repayment term, or monthly payment. If your goal is to become debt-free, refinancing can help you pay off your car loan more quickly.
For example, if you bought a car using a $15,000 loan at 10% interest and took five years to repay it, you would pay back $19,122 in total. However, if you refinanced that same loan at 5% interest, you’d pay just $16,984. That’s over $2,000 in savings that you could use for your other financial goals.
When to refinance an auto loan
If you’re trying to decide if refinancing a car is a good idea, here are four situations when it can be a wise decision:
- When your credit score improves: If you bought a car straight out of school, when you had an entry-level salary and a low credit score, you likely took out a high-interest loan. But if your income and credit score has improved since then, you could refinance an auto loan at a much more competitive rate.
- When interest rates decrease: Car loan interest rates fluctuate along with the market. For example, in July 2017, auto loan interest rates hit a six-month low, reported Edmunds. If you bought a car when rates were higher, you can take advantage of the new loans by refinancing.
- If you were taken advantage of: Going into a car dealership can be overwhelming, and it’s easy for a high-pressure salesman to get you to spend more than you can afford. If you signed a bad deal on a car, you could refinance a car loan and reduce the interest you pay.
- You need a lower payment: If you can’t afford your current monthly payments or want to give yourself more breathing room, refinancing your car loan can allow you to extend your repayment period and get a lower payment. You’ll likely pay more in interest over time with this method, but you can get much-needed relief right now.
When you shouldn’t refinance an auto loan
While refinancing is a smart option for some, it probably isn’t a good idea if you have one of the following issues:
- You’re upside down on a loan: If you owe more than the car is worth, finding a lender willing to work with you could be difficult. If you do find a company who will give you a loan, it will likely be for a shorter repayment term and have higher monthly payments.
- Your car is older: If you have an older vehicle, getting a refinancing loan can be hard, as well. Some banks will not refinance loans on cars that are more than seven to 10 years old.
- Your balance is too low: Most banks have a minimum loan balance. If you owe less than $7,500, you might be ineligible for refinancing with some lenders.
How to get an auto refinance loan
If you’ve decided to refinance a car loan, you can take out a new loan in just six steps:
1. Check your credit
Before shopping around, make sure you check your credit report and your credit score. By knowing that information ahead of time, you’ll have a better idea about what kinds of interest rates you can receive.
2. Check out banks and credit unions
Many banks and credit unions offer auto loan refinancing. In addition, several of them allow you to get quotes on a refinancing loan without doing a hard credit pull, so there’s no impact on your credit.
Banks that offer car loan refinancing include:
- Bank of America
- Capital One
- Navy Federal Credit Union
- Wells Fargo
3. Compare offers
Shop around and get quotes from three to five different banks or credit unions to get the best deal. Sometimes, the interest rate can vary as much as 1% to 2%. By looking at different loan options, you can find the loan term and interest rate that works for you.
4. Provide documentation
When you find an offer you’re happy with, make sure you have the required documentation on hand. Each lender will have their own requirements, but generally, you should collect the following:
- Name, address, and Social Security number
- Employer information
- U.S. citizenship status
- Purchase agreement of the bill of sale from when you bought the car
- Car registration
- Car title, or previous loan agreement
- Lease buyout information
- Proof of income, such as a W-2
- Federal tax returns
- Vehicle Identification Number (VIN)
5. Submit an application
Some banks allow you to submit the loan application online, but others require you to come into a branch and fill out the application in person. In many cases, you will find out if the bank approved you within 24 hours.
6. Manage your new loan
Most banks will work with your old lender to pay off the original loan on your behalf. That process can take two to three weeks before the loan goes through, so it’s important to make any payments that are due in the meantime. Once it’s complete, your new lender will notify you about your account and how to start making payments.
Speeding up repayment of your auto loan
A high-interest loan is sometimes a harsh reality. When you need a vehicle to get to work and you have bad credit, you might be forced to take whatever loan and interest rate you can get.
But as your situation improves, you can correct those issues by refinancing your loans and getting better terms.
If you’re looking for other ways to cut your transportation costs, shopping around for new car insurance each year can help you save hundreds.
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