All about car loan refinancing

Car loan refinancing enables borrowers to replace their existing auto loan with a new one under more favourable terms, such as lower interest rates or adjusted loan periods. It offers the opportunity to reduce monthly payments, shorten the loan term, or adjust other terms.

However, borrowers should carefully research and compare offers from multiple lenders, considering factors like fees, credit impact, and options to ensure they align with their financial goals. By assessing their options and selecting the most suitable refinancing deal, borrowers can effectively manage their auto loan and potentially save money over the long term.

We help you explore the world of refinancing a car loan, including the costs and benefits of refinancing, what you should consider, and how to start the process.

What is auto refinancing?

Auto refinancing is a financial strategy where a borrower replaces their current car loan with a new one from a different lender or with the same lender but under revised terms. The goal is to get better loan conditions to reduce interest rates, lower monthly payments, or get a shorter repayment period. Refinancing helps borrowers capitalize on changes in their financial situation, market conditions, or creditworthiness to secure more favourable terms.

Borrowers apply for a new loan by providing information about their income, credit history, and vehicle. Once approved, the new car loan pays off the current loan, and the borrower makes payments according to the revised loan term. While auto refinancing can save money and improve financial flexibility, borrowers should consider any associated fees, the impact on their credit score, and the overall cost of the new loan compared to the savings achieved.

What do lenders look at when determining your eligibility to refinance a car loan?

Lenders typically consider several factors when determining eligibility for car loan refinancing:

• Credit score: A higher credit score indicates lower risk for the lender and may qualify you for better interest rates and terms.

• Income and employment history: The current lender assesses your income stability and employment history to ensure you have the means to repay the loan.

• Loan-to-value ratio: This ratio compares the amount you owe on the car to its current market value. A lower LTV ratio generally results in better refinancing terms.

• Current loan status: Lenders look at your payment history and current loan status to assess your creditworthiness.

• Debt-to-income ratio: This ratio compares your monthly debt obligations to your income. A lower ratio indicates less financial strain and may improve your chances of approval.

• Vehicle age and mileage: Lenders may have restrictions based on the age and mileage of the vehicle you're refinancing your current car loan.

• Purpose of refinancing: Whether you're seeking to reduce monthly payments, lower interest rates, or change loan terms, lenders will consider how your goals align with their lending criteria.

Pros of auto loan refinancing

There are several benefits when you refinance a car loan with your current lender.

Lower interest rates

Lower interest rates can significantly reduce the total amount of interest paid over the life of the loan, potentially saving hundreds or even thousands of dollars. It can free up funds for other financial goals or allow you to pay off the loan faster.

Reduced monthly payments

Lowering your monthly payments through refinancing can provide immediate financial relief, especially if you're experiencing temporary financial hardship. You can use the extra cash to plan for spending and saving towards your other goals and obligations.

Shorter loan term

Refinancing to a shorter loan term allows you to pay off the loan faster and become debt-free sooner. While this may result in slightly higher monthly payments, it can save you significantly on interest payments over the life of the loan.

Better loan terms

Switching from a variable to a fixed-rate loan can provide stability and protection against future interest rate increases. Adjusting loan terms to better align with your financial goals and budget can make managing your finances easier and more predictable.

Cash-out option

Cash-out refinancing allows you to borrow more than you owe on the car and receive the difference in cash. You can use the extra money for various purposes, such as covering unexpected expenses, making home improvements, or consolidating higher-interest debt.

Cons of auto loan refinancing

While there are many benefits to refinancing a car loan, we should also look at some of the disadvantages.

Refinancing fees

Refinancing typically involves fees, such as application fees, origination fees, or prepayment penalties on your current loan. These fees can offset potential savings and should be factored into your decision-making process.

Impact on credit score

Multiple credit inquiries during the refinancing process can temporarily lower your credit score. Additionally, closing your existing loan may affect the average age of your credit accounts, which can also impact your credit score.

Risk of extended loan term

While extending the loan term can lower monthly payments, it also means paying more interest over time. You may pay significantly more for the car than its original purchase price.

Negative equity

If you owe more on your car than its current value, also known as being "upside-down" or having negative equity, it may be challenging to refinance. Lenders may be reluctant to approve a loan with a high loan-to-value ratio, making it difficult to secure favourable terms.

Loss of benefits

Refinancing may result in losing the benefits or perks with your current loan, such as loan forgiveness programs or deferment options. It's essential to carefully review the terms of your current loan and any potential refinancing offers to ensure you're not giving up valuable benefits.

Can I refinance my car loan and get cash back?

Yes, you can refinance your car loan and get cash back through a process known as cash-out refinancing. It involves refinancing your current auto loan for more than you owe on the vehicle and receiving the difference in cash. Lenders typically have limits on the loan-to-value ratio and may not approve a loan that significantly exceeds the car's current market value.

Cash-out financing may also have higher interest rates than standard lending. Your monthly payments may likely increase because of the larger loan amount, and extending the loan term to keep payments manageable can result in paying more interest over time.

How to compare car loan refinance offers in Canada

Comparing car loan refinance offers in Canada involves several steps to ensure you get the best deal. Here's a guide to help you:

1. Check your current loan terms: Before comparing offers, review your current car loan terms, including the interest rate, remaining balance, and any fees associated with refinancing.

2. Know your credit score: Your credit score plays a significant role in the interest rate you qualify for. Obtain a copy of your credit report and score to understand where you stand. The higher your score, the better your chances of qualifying for lower interest rates.

3. Research lenders: Look for lenders in Canada that offer car loan refinancing. Banks, credit unions, online lenders, and specialized car loan companies are common options. Research their reputations, interest rates, fees, and customer reviews.

4. Compare interest rates: Interest rates can vary significantly among lenders. Request quotes from multiple lenders and compare their interest rates. Remember to consider both fixed and variable rates and introductory rates that may apply.

5. Evaluate fees: Consider the fees associated with refinancing, such as application fees, origination fees, prepayment penalties, and other charges. These can impact the overall cost of refinancing.

6. Consider loan terms: Determine the loan term length you're comfortable with. Shorter loan terms typically come with higher monthly payments but lower overall interest costs, while longer terms offer lower monthly payments but higher overall interest costs. Choose a term that aligns with your financial goals and budget.

7. Calculate savings: Use online calculators or spreadsheets to estimate how much you could save by refinancing your car loan. Compare the total cost of your current loan with the total cost of the refinanced loan, factoring in interest rates, fees, and loan terms.

8. Check for special offers: Some lenders may offer special promotions or incentives for refinancing, such as cashback bonuses or discounted interest rates. Be sure to inquire about available offers to further reduce costs.

9. Read the fine print: Carefully review the terms and conditions of each refinancing offer, paying close attention to any potential hidden fees, penalties, or restrictions. Make sure you understand all the terms before committing to a new loan.

10. Consult with a financial advisor: If you're unsure about which offer is best for your financial situation, consider consulting with a financial advisor or loan specialist who can provide personalized advice based on your needs and goals.

What information do I need to refinance my car loan?

To refinance your car loan in Canada, gather essential details about your existing loan, including the lender's name, account number, remaining balance, and interest rate. Provide personal information such as your full name, date of birth, residential address, and contact details.

Have documentation of your employment status, including your employer's name, contact information, job title, length of employment, and proof of income. Your credit history and score are crucial, so consent to allow the lender to pull your credit report. Also, have information about your vehicle ready, including make, model, year, mileage, VIN, and current registration details. You may also need to provide proof of auto insurance coverage.

Once you've gathered all the necessary information and documentation, approach lenders with your loan preferences, such as the desired loan term and type of interest rate. Consider whether you prefer a fixed or variable rate and any specific features you're looking for in the new loan. Be prepared to provide identification documents for verification purposes, such as a driver's license or passport.

Some lenders may require additional documentation, such as proof of residency, references, or a co-signer if necessary. By having all the required information ready and understanding your preferences, you can streamline the refinancing process and improve your chances of securing a better loan deal.

Car loan refinancing for a shorter vs. longer loan term

Choosing between a shorter or longer loan term for car loan refinancing has financial implications. A shorter term means higher monthly payments but lower overall interest costs, allowing quicker loan payoff and equity buildup. Conversely, a longer-term offers lower monthly payments but higher overall interest expenses. Consider both options carefully to align with your financial goals and budget.

Can you refinance a car loan with bad credit?

Your credit score is important for financing a car. It determines whether you qualify for credit and the terms and agreements of your original and refinanced loan. A bad credit score means you don't have a strong credit profile. Several factors affect your credit score, such as missed payments, too many credit inquiries, and a high credit utilization rate. Your refinancing options may be limited if you have bad credit.

Refinancing a car loan with bad credit is possible but can be challenging. To improve your chances, improve your credit score by paying bills on time and reducing debt. Shop around with various lenders, including banks, credit unions, and specialized lenders, comparing interest rates and terms.

Consider a cosigner with good credit to get a car loan and secure better terms or offer a larger down payment to reduce the loan amount. Though their interest rates are higher, subprime lenders may be more willing to work with bad credit. Be prepared for higher costs and carefully assess whether the refinancing benefits outweigh these additional expenses.

Are there fees to refinance an auto loan?

Yes, there are often fees associated with refinancing an auto loan. These fees can vary by lender and may impact the overall cost-effectiveness of refinancing. Common fees include:

• Application fee: Some lenders charge a fee for processing your refinancing application.

• Origination fee: This fee covers setting up the new car loan.

• Prepayment penalty: Some lenders charge a fee if you pay off your existing car loan early.

• Notary fee: Documents related to the financing may need to be notarized.

• Administrative fees: Some lenders may charge administrative fees for handling paperwork and other related tasks.

Alternatives to car loans

There are many ways to finance car purchases. The ideal score for a car loan is usually above 600, and scores closer to 700 are considered more favourable. For example, 746 is considered a good credit score, and individuals are likely to secure a car loan with that credit history.

Paying cash

If you have enough savings, paying cash for a car is the most straightforward way to avoid interest and loan fees. This option eliminates debt and may give you leverage to negotiate a better price.

Personal loans

A personal loan can be used for various purposes, including purchasing a car. They often have fixed interest rates and terms and don't require collateral. However, they might come with a higher interest rate than car loans, especially if you have a lower credit score.

Credit cards

Some people use credit cards to purchase a car, particularly if the card has a low or 0% introductory interest rate. This can be risky, as high credit card interest rates can apply after the introductory period ends and affect your credit utilization ratio.

Leasing

Leasing a car can be a good alternative if you prefer lower monthly payments and enjoy driving a new car every few years. Leasing typically involves lower payments, but you won't own the car at the end of the lease term, and there may be mileage limits and other charges.

Build credit and spend conveniently with KOHO

A good credit score gives you better opportunities when it comes to car refinancing. With KOHO's credit-building products and expert guidance, you can improve your credit score and get better terms and approval rates if you want to refinance your car loan. We have many plans for spending and saving to help you on your financial journey.

Start with a virtual credit card to spend conveniently from your mobile wallet while earning cash back on purchases. KOHO reports payment activities and credit usage to the major credit bureaus. Ensure you make timely payments and keep your credit utilization within 30% to increase your score. You can also apply for overdraft protection coverage as an emergency fund if needed.

If you're looking to buy a car, you can use a high-interest savings account to kickstart the process. Earn interest on every dollar deposited so you don't have to take out as big of a loan.

Whether you need a free credit score, resources to help you build healthy financial management skills, or KOHO for business products, we've got you covered. Start building your credit with KOHO today.