How Does Auto Refinancing Work?

An application for a car loan.
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When you refinance an automobile, you replace your existing loan with a new one. Refinancing provides an attractive option if you want to cut your monthly payments or reduce the amount you spend on interest. Many people refinance as a result of car ownership changes caused by marriage or divorce. Regardless of your motive, the basic refinancing process remains the same.

Loan Application

The refinance process begins with a credit application. You can apply for refinance loans from banks, credit unions and finance companies. For convenience, many firms enable you to apply online as well as in person. Through the application, you provide the lender with specific information about your car such as the vehicle identification number, mileage and general condition. You also disclose personal details including your Social Security number, date of birth and sources of income. You cannot refinance a loan unless you have a valid driver's license and car insurance.

Your Car

On a refinance as with a purchase loan, your car serves as collateral for the debt. This means your lender can take the car and sell it if you don't repay the loan. Your car's value must exceed the amount of the loan, otherwise the lender would lose money in the event of a loan default. If your existing loan balance exceeds the current value of your car then you're "upside down" with negative equity. You can still refinance but only if you pay down the balance before taking on the new loan. Wear and tear, accident history and even the condition of the paintwork can have a positive or negative effect on the value of your vehicle.

Credit Score

Lenders use your credit report to gauge the level of risk involved in providing you with a loan. High scores equate to minimal levels of risk while low scores are synonymous with high default rates. Credit scores change on a monthly basis, driven by factors including your payment history and the balances you keep on your credit cards. You can potentially get a lower interest rate with a refinance if your credit score has risen since you bought your car. Conversely, if your credit score has fallen, your rate might rise. In a worst case scenario, a lender may decline an application based on a low credit score.

Debt To Income

Regardless of your credit score and the value of your car, you can't refinance unless you have the capacity to repay the loan. Lenders use an equation called debt-to-income to calculate your monthly expenses as a percentage of your income. Acceptable DTI ratios vary greatly between lenders but you can't refinance if the new loan would take your DTI above the acceptable level. This may seem counter-intuitive especially if a refinance would result in a reduced monthly payment. However, your existing loan was approved based on your income situation when you bought your car rather than your current financial status.


Few of the obstacles blocking the path of a refinance are insurmountable. For example, you could resolve DTI issues by adding a cosigner. Likewise, the addition of a co-borrower with good credit could have a positive impact on the proposed interest rate. However, one thing you can't fully control is the collateral. Cars eventually become obsolete. At some point, excess mileage or actual age will reduce your care's value to little or nothing. At that time, you'll need to forget about a refinance and start thinking about a new purchase loan.

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