How Does Car Refinancing Work?

A car refinancing can lower your interest rate, reduce or increase your payment period and decrease your payments. When a car is refinanced, the original loan is paid off by your new lender, and the lender then establishes a loan agreement with you.

Definition

A car refinancing occurs when a borrower replaces the original loan with a new loan, whether from another lender or with the same bank. The new lender pays the entire original loan and gets the title to the vehicle being refinanced. A new car financing contract is drawn up between the borrower and new lender. The borrower makes payments on the car loan as usual, but he now makes them to the new lender instead of the original lender.

Process

A borrower does not need to wait for a certain time to look into car refinancing, unless his original loan contract has a prepayment penalty. Such a penalty charges a fee if the loan is paid off early, but this clause is more often seen in mortgages than in car loans. The borrower can talk to his original lender about refinancing options or gather quotes from other lenders. Once the borrower has found the quote that meets his needs, he applies for the loan. The application process varies from lender to lender, but it should not vary greatly from the original loan application process.

Advantages

Refinancing a car loan comes with many advantages. One major reason for refinancing your car loan is to reduce the interest rate. If you took out a car loan while your credit was bad, your interest rate may be much higher than the prime rate. Refinancing after your credit is cleaned up can save a great deal of money. You may also choose to lower your car payment by extending the amount of time for the loan contract. If you extend the contract, you will owe a higher amount due to accumulated interest, but the monthly car payment may be lower.

Disadvantages

If you are in a worse credit situation than when you initially got the car loan, you may not be able to find refinancing terms that are favorable to you. Your car may not be eligible for a refinancing due to the amount of equity in the vehicle --- namely, if you have negative equity. Negative equity, referred to as an upside down loan, occurs if an auto loan is higher than the car's actual value. The lender may also refuse to refinance if the car loan is not large enough.