What Happens When You Refinance Your Car Loan?
You’re thinking about refinancing your automobile for whatever reason — a lower interest rate, better terms, to transition from a lease to ownership. What exactly happens when you do that? What happens to the old loan? What happens to your credit? These are some of the things that happen when you refinance your automobile loan.
Your New Lender Will Pay Off Your Old Loan
Your new lender will pay your old loan off directly. You don’t have to worry about it anymore. You just focus on when and how to pay your new lender. The only thing you should worry about is asking for documentation or other proof showing that this payment and title transfer was made.
A New Loan Is Created
Your new lender takes the amount due on the old loan, adds the new interest and amortizes it under the terms of the new loan. Let’s say you bought a car for $20,000 at 8% interest for 60 months and had been paying $406 every month for a year.
You are now down to 48 months and $15,000. Your new lender has given an interest rate of 3.5%. Your new payment will only be $335 a month. Alternatively, you and your lender might agree to different terms. You might extend the loan back out to 60 months and only be paying $273 a month.
On the other hand, depending on the lender, the age and make of the car and its mileage, you may not be able to get a lower interest rate or a longer term, so it’s important to evaluate your financing options in the first years of your owning this car.
There are many variables that can be played with, from term to interest rate, to the down payment. Much depends on the age of the automobile, your current credit score and your debt to income ratio.
Your Credit Report Will Be Pulled
Several things about refinancing an auto can affect your credit score.
- A lender or lenders pulling your credit report is known as a “hard inquiry” which can affect your credit score. Any time someone pulls your credit report, it can have a negative impact—though usually minimal and temporary.
- Your old loan will be paid off, and a new loan will be created in its place.
- Your new loan will be noted by all the credit bureaus as a new account. Too many new accounts in a period of time can impact your credit score.
Unless you’re in the process of getting a mortgage or applying for multiple other credit accounts within a short amount of time, refinancing your auto loan should not have a negative impact on your credit score.
If Your Payment Changes, So Does DTI
One of the chief factors lenders look at when deciding whether to extend credit is your Debt to Income Ratio. DTI is determined by adding up all your monthly debt payments and dividing the sum by your income. The more money you owe in debt every month, the higher your DTI. Most lenders look for a DTI under 40%. If you refinance and you have a lower payment, that reduces your monthly debt, therefore, a lower DTI.
You May Pay a Minimal Fee
While closing costs on a mortgage refinance can be expensive, costs associated with refinancing your auto are minimal. Your new lender might charge a small application fee for pulling your credit, and another, possibly, for pulling data on your automobile to make sure it hasn’t been in a major accident that would reduce its value. There might be another small fee for transferring the title from your current lender to your new lender. Still, with all that, you’re probably looking at less than $100.
At Credit Union of Texas, we do not charge any fees for refinancing your car loan over to us!
Refinancing an automobile is much easier and faster than refinancing a home. However, it still requires careful shopping for the right lender and the right terms. Though any new loan can have an impact on your credit score in the short run, getting a better financing arrangement should significantly help your credit history in the long run. If you’d like to learn more about auto refinancing, contact us!