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Refinancing a Car Loan With Bad Credit

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In a Nutshell

Having bad credit doesn’t mean you can’t get an auto loan or refinance your current auto loan to try to get better terms. Refinancing your auto loan can help you get a lower interest rate, lower monthly payments, and save money on the total cost of your loan. This article will talk about how refinancing works, the pros and cons of refinancing your auto loan, and some of the factors you should consider when shopping for a refinance loan.

Written by Krishna Patel
Updated December 8, 2021

A new or used car is an expensive purchase, and many people can't afford to buy a car outright. Luckily, you can get an auto loan to help with this expense. The monthly payment for your car loan varies depending on the terms of the loan. Having a good credit score does help you get a lower interest rate, whether you’re financing a new car loan or refinancing an existing loan. But having bad credit doesn’t mean you can’t get an auto loan or refinance your current auto loan to try to get better terms. 

Refinancing your auto loan can help you get a lower interest rate, lower monthly payments, and save money on the total cost of your loan. This article will discuss the factors to consider if you’re thinking of refinancing your auto loan, how to refinance a loan, and what role your credit score plays in refinancing. 

Refinancing a Car Loan

Refinancing an auto loan means getting a new loan with better terms. The new loan pays off your existing auto loan, so after the refinance you’ll just make payments on the new loan. 

Pros and Cons of Auto Refinancing

If you have bad credit you probably got a high interest rate on your car loan. As we saw, interest adds to the cost of your car, which is why you want to try to get the best auto loan rate possible. Refinancing is a potential path to a better rate. This means less interest will accrue monthly, which saves you money over the life of your loan. This is the biggest advantage of refinancing your loan.

There are some drawbacks of refinancing to consider as well. Many lenders charge origination fees for new loans to cover the time they spend processing your loan. One way to estimate these processing costs is by noting the loan APR (annual percentage rate) which is often mentioned in car and loan commercials.

There are also fees to register your car and transfer the title with the DMV. Another pitfall is that your car’s market value will drop. That’s because getting a new loan technically acts as a sale of the car. This means if you currently have a new car it will be considered a used car under the refinanced loan.   

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When Is It a Good Idea To Refinance a Car Loan?

Despite the potential drawbacks, refinancing your car loan can lead to a lot of savings. So, how do you know if it’s worth it for you to refinance? You’ll want to consider:

  • If you still have multiple payments to make… borrowers who are close to paying off their existing loan are less likely to benefit from refinancing than borrowers who still have many payments to make.

  • If your credit score has improved... credit scores change over time. If you’ve boosted yours since you took out your loan, refinancing may be a good idea because you’re more likely to get better loan terms. 

  • If the interest rate on your current loan is above the market’s average rate… if you took out your loan when interest rates were high overall but they’ve since dropped, it’s worth looking into refinancing to see if you can take advantage of the lower rates.

  • If you are having trouble affording your current car payments… refinancing your loan may be a way to lower your monthly payment.  

You might not be a good fit for refinancing if your current loan has prepayment penalties, if you owe more than your car is worth, or if you’re behind on payments.

If You’re Upside Down on Your Auto Loan

If you are upside down, also known as being underwater, on your auto loan, you currently owe more on your car loan than the fair market value of your car. This can make refinancing an uphill battle when it comes to getting approval or better terms. Some lenders may still approve you and grant a loan that covers your current loan but this could put you deeper in debt.

It’s important to compare six factors for every loan option you look at to make sure you are putting yourself in a better position with the refinanced loan. They are the:

  • Total loan amount

  • Interest rate

  • Length of loan

  • Monthly payment

  • Total interest paid over the lift of the loan

  • Total cost of loan

Start by looking at your existing loan. Let’s pretend you put $0 as down payment and borrowed $10,000 with 15% interest when you purchased your car three and a half years ago (42 months in loan speak). Here are your original terms: 

Original Loan Amount Interest RateLength of Loan (Number of Months)Monthly PaymentInterestTotal Cost of Your Loan
Existing Loan$10,00015%84$193$6,209$16,209

After 42 payments you check your account online or call your lender to find out your payoff amount. and they tell you your payoff amount is $8,103. That 15% interest rate is the reason you still owe so much after making $8,106 (42 monthly payments of $193) in payments. and why refinancing could help you reduce this load.  

If you explore some different options numbers like the below, you can begin to see where you could end up saving over the life of the loan. Let’s assume you don’t want to spend any additional time paying off your loan so we’ll stick to having 42 monthly payments (3.5 years) remaining.

Payoff/Loan Amount Interest RateLength of LoanMonthly PaymentInterestTotal Savings
Refinance Option 1$8,10310%42$229 (+36)$1,534$4,682
Refinance Option 2$8,1037%42$218 (+25)$1,057$5,154

In both Options 1 and 2 we started with a lower interest rate than your original loan. Although in those options your monthly payments would increase, by the end of the loan you would save thousands on interest. If you can’t afford a higher monthly payment,Increasing your payments may not be an option in which case you might want to look for a loan where you choose a longer term, but lower your interest rate like in Option 3.

Payoff/Loan Amount Interest RateLength of LoanMonthly PaymentInterestTotal Savings
Refinance Option 3$8,10312%63$174 (-19)$2,858$3,345

By getting an interest rate that’s just 3% better than the current rate and extending the length of the loan, Option 3 gives you a lower payment but still saves thousands over the life of the loan. These numbers came from the Allstate Auto Loans Calculator and Comparison tool, one of the many refinance calculators you can use to help research if refinancing is a good option for your needs. 

How To Refinance a Car Loan

  1. Check your credit score.  

  2. Shop around for the best loan offers. Consider applying to prequalify for loans which could speed up the application process. 

  3. Apply for the best loan offer.   

  4. After acceptance of your application — congratulations! — complete the paperwork and begin making payments on your new loan.  

It can take a surprising amount of time to pull together what seems like basic information, but doing this first will put you in the best position to find and apply for refinancing deals. To get started, here’s what you’ll need to collect:

Your Current Loan Information: Collect your lender’s information, the current balance on your loan (also known as the loan payoff), the interest rate, and how many loan payments you have left. Having this information at your fingertips will make it easier to compare potential new loans and see which is the better deal. 

Your Personal & Financial Information: Have your personal information ready for filling out forms including your Social Security number. You may even need to have your previous addresses, employment history, and tax returns handy. You’ll also want to be able to list your monthly expenses and debt obligations like student loans. Finally, make sure you have proof of income, which could be as simple as a recent pay stub. 

Your Car’s Information: Gather details on your car including the mileage, model, year, and vehicle identification number. Have your auto insurance information available as well. Check the current value of your car using a site like Kelley Blue Book. You’ll need to compare the current value to your payoff amount to see if you are upside down on your loan.   

Auto Refinancing and Your Credit Score

Checking your credit report is a crucial step in your refinance journey for many reasons. You’ll want to know what’s in your credit report and what your credit score is because lenders will check it when you apply for a loan. Your credit score is usually a deciding factor in refinancing an auto loan. If you had bad credit, but it has improved, it will help your chances of getting a better loan. If your score hasn’t budged it’s going to be more difficult to get a lower interest rate. That said, don’t give up. There are lenders who are willing to work with borrowers who have bad credit scores 

Your credit score is an ever changing mashup that gives lenders an idea of how reliable a borrower you are. It’s created from information in your credit report. Every time you make an on-time credit card or loan payment you help maintain or improve your credit score.  

You can improve your credit score in as little as a few months to inside of a year. On the other side, late payments or defaults can cause it to go down. It can feel like judgment from on high but don’t take the number personally, even things like a lender running your credit report, known as a hard credit inquiry, can temporarily affect your score. You have the power to impact your score in other ways. If there are any items on your credit report that you feel are not accurate, take the time to try and dispute the errors. It could improve your score and therefore your chances of getting a better loan.   

Other Factors To Consider

Take time to shop around and compare refinancing offers from different lenders. When shopping around, don’t forget to check with your current lender! Financial institutions offer competitive rates to draw business and that includes the business of existing customers. Check with your current auto loan provider to discuss options and find out if they can offer you better terms than you currently have. 

The sheer number of different lenders across financial institutions from banks to credit unions can make this feel overwhelming. It can be tempting to go for the first lender that offers a lower rate. But before you apply, think about what you want in a new loan and what you want to avoid. 

For example, lowering your monthly car payment could feel great in the short term, but it may also increase the total number of payments you need to make. This means you’ll be paying for a longer time, which means you’ll pay more in interest in the long run. Always make sure to look at how much any loan is going to cost you over the life of the loan. This is especially important with car loans. Most cars’ values are always going down. As the value decreases, you’re more likely to get underwater on your loan if you don’t choose wisely.

You may not have to go it alone. Consider applying with a co-signer. A co-signer is someone, often a family member or partner, who agrees to take responsibility for your loan if you stop making payments. A co-signer may have a higher credit score or income which will make you a more attractive prospect as a borrower by association. This can open the door to better loan terms and interest rates. Co-signing your auto loan does not give your co-signer an ownership interest in your car.   

Let's Summarize…

Refinancing your auto loan could potentially save you money over the life of your loan. It’s worth exploring if your income, credit score, or national auto loan rates have changed. The time it takes to gather your information, shop around, and apply could literally pay off if you end up with a loan with better terms. Regardless of outcome, knowing the best auto loan rates and that you could try again if things change down the road is a worthwhile endeavor for any car owner.

Written By:

Krishna Patel


Krishna Patel is a writer and attorney. She is licensed to practice in New York and received her J.D. at Georgetown University Law Center. While in law school, Krishna worked in a clinic that helped low-income renters purchase their apartments and incorporate their building int... read more about Krishna Patel

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