3 Roadblocks To Auto Loan Refinancing

related category image

Point of Interest

Consumers looking to refinance their auto loans need to keep three key factors in mind: their credit score, the age of the vehicle and the value of the vehicle. These three factors can become roadblocks when trying to refinance an auto loan.

If you had bad credit or simply didn’t get the best rate when locking in your auto loan, you’re probably wondering how refinancing an auto loan works and whether it’s the right move for you. Refinancing your loan can be the right call, but it can also be difficult to do when there are roadblocks in place.

In theory, auto loan refinancing is simple: you have an auto loan that has a less than stellar interest rate, so you reapply for a loan with a new lender at a lower rate, and when approved, that loan will pay off and replace your current car loan. You’ll make payments to the new lender at the new interest rate instead.

Consumers do this to save money on interest, pay off the loan sooner or secure more favorable loan terms. You can attempt to refinance your auto loan whenever you’d like, but some situations lend themselves better to refinancing than others.

Sometimes, consumers who aren’t in the strongest position to refinance will attempt to do so anyway, which often leads to a wall of rejections and frustration. If you want your refinance journey to go smoothly, it’s important to avoid the major obstacles consumers face when trying to refinance or learn how to overcome them.

How does refinancing an auto loan work?

To refinance an auto loan, you need to contact lenders and ask about refinance rates, terms and qualifications. You should contact multiple lenders as the first step in refinancing to compare rates and perhaps even negotiate. If one lender offers 6.50% APR and you have an offer for 6.0% APR, ask if the lender with the higher interest rate can match or beat the lower rate.

There’s not much point in going through all this, though, if you have no shot at approval. Often, lenders can preapprove you without doing a hard credit check so you can compare rates without harming your credit score.

Once you settle on a lender, you’ll need to apply and allow the lender to perform a hard credit check. Once that’s done, the lender will let you know if you’ve been approved. A hard credit check may temporarily ding your credit score, but pulling your credit report is standard practice when you apply for loan products. If you are approved, the new loan will pay off and replace your old loan, but you should keep making payments on your original car loan until told otherwise.

If you’re not approved for your new auto finance, it’s probably because you fell short, in one way or another, of the lender’s expectations. That doesn’t necessarily mean you’re doomed to high-interest payments for the life of the loan. It could just mean you need to work on your credit score or whittle down the loan amount a little more.

3 things that can prevent an auto refinance

Lenders are required to tell you why you aren’t approved for funding, but that often happens via a letter sent by snail mail, so it can take a while to get an answer on why you were declined by a lender. If you want to figure out why you were declined before the letter arrives, you can often figure it out by taking a step back and analyzing your situation.

Some of the more common roadblocks or reasons for being denied a loan for refinancing are due to:

1. You owe more on your car than you can get a loan for.

If you owe more money on your car loan than your car is worth, you’re considered upside-down or underwater on your auto loan. You also may have heard it referred to as having negative equity. Lenders don’t like to refinance cars that have upside-down loans because there are more risks and less potential for reward.

The general rule is that brand new cars depreciate at least 10% in value the moment they’re driven off the lot. This loss of value often leads to consumers biting off more than they can chew, which in turn leads to underwater car loans.

Let’s say you want to buy a brand new car worth $25,000. You put $2,000 down and finance the rest. This means you take out a loan for $23,000.

The moment you drive that brand car off the lot, it’s worth no more than $22,500. As mentioned, new cars depreciate by 10% almost immediately — and 10% of $25,000 is $2,500. So, the new car you bought for $25,000 would be worth just $22,500 moments after buying it.

Your new car is now worth a little over $22k, but you owe $23,000 on the loan, so you’re playing catch up before you’ve even begun.

2. Your vehicle is too old to refinance at a low interest rate.

If your car older, you may have a hard time finding lenders willing to work with you on refinancing. This has a lot to do with the value of the vehicle. Older cars are often worth less than newer ones and tend to lose value more quickly, so lenders are going to be less likely to take on the financial risk that comes with refinancing an older car.

Furthermore, owners with older cars will get worse interest offers when refinancing — if they get any offers at all. Some lenders, like Capital One, will not refinance cars older than 6 years. Other lenders may extend offers that look good on the surface, but often have hidden fees and restrictive terms.

Before accepting an offer, you should make sure your new loan comes with advantages your old one doesn’t have. Refinancing a loan often will involve origination or service fees, so you shouldn’t do it unless you believe you’re improving your situation by securing a lower interest rate or negotiating lower monthly payments. Ultimately, you should weigh your options and decide what move is best for your financial health.

3. Your credit score is too low to refinance or your finances aren’t in order for approval.

A bad credit score or messy finances can be an obstacle when securing any type of loan, and auto loans are no exception. Unless the lender specializes in bad credit auto loans, most lenders prefer borrowers with good credit — the higher the better. Lenders look for other signs as well to make sure they’re financing at a minimum risk. Your income, job security, debt-to-income ratio and credit utilization ratio can all factor into a lender’s decision when choosing whether or not to refinance you.

Ultimately, a lender’s goal is to make a profit. Lenders can only profit if borrowers repay their loans, and since no lender can predict the future, they have other methods to predict whether or not a borrower will default on a loan. Every lender is different, which is why it’s worth reaching out to several before accepting an offer. Some value credit scores more while others look at your overall financial picture.

If you’re unsure as to whether a refinance would benefit you, try using an auto loan calculator to get an estimate of how much you will be paying in interest each month and over the life of the loan. It may be easier to decide one way or the other if you have an idea of what the APR means in terms of dollars.

According to the FICO model, a credit score below 669 is considered “fair” or below. Anything above 670 is considered good, and scores above 740 are considered very good. If your score lands between 800-850, which is the max, you fall into what FICO calls “exceptional“ credit.

You can always boost your shot at locking in a refinanced auto loan by improving your credit score. The best way to do that is to pay your bills on time, every time.

Bents Dulcio

Personal Finance Contributor

Bents Dulcio is a personal finance writer based out of Orlando, Florida. His work has been featured in Debt.org, InCharge.org and elsewhere.