Besides your home, your car is likely one of the most expensive items you’ll ever purchase, and with good reason, since you probably use it almost every day. Even though your car is incredibly useful, it doesn’t mean that you have to pay high interest over the life of the auto loan.
If your current loan has a high interest rate and your credit score has substantially improved since you first purchased your car, it might be a good time to start shopping around. A high interest rate could mean that you're doling out a hefty sum in car payments each month; in that case, figuring out a way to lower those monthly payments can help free up some cash every month to meet your other financial goals.
According to consumer credit statistics released by the Federal Reserve, the national average for U.S. auto loans is 5.14% on 60-month loans on new cars, as of May 2020. However, rates on auto loans vary based on factors like loan terms, the age of your car, credit score and additional lender risk factors like driving history and age. If interest rates are dropping, or if your credit score has substantially improved since you first purchased your car, it might be a good time to consider a change to your car loan.
If you find yourself with a higher interest rate on your car loan, a personal line of credit could be a good option for you. Here’s how a personal line of credit works: this type of financial product provides you with access to a set amount of money for a fixed number of years (called the draw period). It’s useful in this situation for several reasons:
- Refinancing to a lower interest rate: First and foremost, a personal line of credit could help reduce your interest rate on your auto loan and thus, reduce the total amount owed over the life of the loan.
- Refinancing multiple forms of debt: A personal line of credit might help you refinance your high-interest auto loan and additional forms of debt such as student loans into one low monthly payment.
- Flexible use of funds: This type of financial product can also offer the flexibility to pay for additional financial needs — not just the costs associated with your auto loan — as they arise during the draw period.
While you’re determining whether a personal line of credit is a good idea for you, it’s important to understand the basics of a traditional auto loan first. If you’re wondering how to refinance a car loan, this is how the process generally works.
Understand the details of your current auto loan
Like most loans, it’s important to unpack the details. Before committing to any new car or auto loan, it’s important to understand all of your original loan terms to ensure you get the best deal and don’t end up paying any additional money in fees. Some of the most important factors to note include:
- The loan term: Consider how much time is left on the loan overall.
- Interest rate: This is the nominal cost of borrowing the principal (in this case, the loan amount for your car), and it's helpful for comparison shopping down the road.
- The minimum payment you make per month: This is another helpful comparison number to keep in mind.
- Annual Percentage Rate (APR): This is the interest rate plus any extra costs or fees that the lender may charge. In other words, it's the true cost to borrow the principal over the course of a year, expressed as a percentage. Pay close attention to the APR when evaluating your options; under the Federal Truth in Lending Act, all lenders must advertise the APR for consumer loans, so borrowers can make an informed “apples-to-apples” comparison between different products offered by different financial institutions.
- How much of the remaining balance is left on the loan: If you are close to paying off your car in full, for example, then refinancing to a loan that would have you making payments over a longer period probably doesn’t make much sense.
- Prepayment penalties: It will also be important to note any penalties for paying off your original loan early. If there is a fee, you’ll want to factor that number into whether it makes fiscal sense to refinance with a new loan.
- Secured versus unsecured: When evaluating financing options, it’s crucial to understand whether collateral is required to “secure” the loan. In general, an auto loan is “secured” with an asset — the car that you are purchasing. A personal line of credit is unsecured, which means that there is no collateral (that is, the loan would not be secured by the car).
Check your credit
If you're looking to qualify for optimal rates when it comes to consumer loans, improving your overall financial standing can help you achieve this. One of the most important numbers to check is your credit score. If your credit score has substantially improved since you applied for your first car loan, you may be able to refinance to a loan with a lower interest rate. An excellent credit score, along with a history of making timely payments on your original loan, helps to show potential lenders that you are reliable and trustworthy, which may allow you to access stronger refinancing options.
Remember that applying for a new car loan requires a hard credit inquiry from lenders, which may cause a slight dip in your credit score afterward. According to Experian, this dip only tends to be five to 10 points, and a few months of good financial standing could get you back up to where you were pre-inquiry in a few months.
Once you’ve decided to move forward with the process, the best way to prepare for an auto loan refinance is to start gathering all the pertinent documentation you might need to apply. The more you have access to everything, the quicker the process will be for everyone involved. Some essential paperwork to have on hand includes:
- Personal identification: To verify that you are who you say you are and that you’re legally able to drive, any lender you apply with will likely need to see a valid driver’s license. They’ll want to know your social security number, as well.
- Vehicle information: You’ll need to have on hand all of the identifying information pertaining to the car you’re hoping to refinance. This includes your registration and title, the mileage on the vehicle and the VIN, your car insurance information including your provider’s name, policy number, and specific coverage details (like how long you’ve had the policy). Keep in mind that if you’re refinancing through a personal line of credit, your lender may not require vehicle information — verification of the existing loan from the loan provider may be sufficient, depending on the terms.
- Income information: Any lender will want to have an idea of how you’ll be covering the payments on your loan, so you’ll want to gather relevant income documentation as proof. This will include things like recent pay stubs (your last two should suffice, but you can ask the lender for what they’d like, specifically), as well as tax documents, like your most recent tax return or W-2 (this is especially important if you’re a freelance worker).
- Loan information: It also helps to have all the relevant details about your current loan, such as your lender and policy number, and the current balance.
Apply for the best deal
When you’re considering how to refinance a car loan for lower payments, a little research can go a long way. Like with any loan application, it’s essential to shop around for quotes from multiple lenders to compare factors like interest rates and repayment periods and see how your monthly payments would stack up with each option.
Once you’ve done all your research and have determined the best loan for your needs, auto refinancing is as easy as signing the loan documents with your new lender, who will pay off your first loan entirely so that you can start making payments on the new one.
As mentioned earlier, there's more than one way to refinance an auto loan, and one unique option is taking out a personal line of credit. If you’re looking to free up cash in your monthly budget, a personal line of credit could offer you a convenient way to refinance your high-interest car loan at a new, lower (and ideally fixed) interest rate, while covering other personal or household expenses. Here are the basics of how this financial product works:
- With a personal line of credit, you can withdraw as much of the available money you want, up to the limit, during the draw period.
- Interest accrues only on the borrowed sum, not the unused portion.
- Assuming that you stick to the lender’s terms, once the amount drawn against the personal line of credit is paid back, that amount is available for you to borrow from again immediately during the draw period.
In this way, a personal line of credit offers more flexibility — both in use of funds and timing — than a traditional auto loan refinance.
Terms and conditions will vary across lenders, so it's worthwhile to do your research to find the best personal line of credit for you. At First Republic Bank, for example, borrowers have access to a fixed-rate personal line of credit with low Annual Percentage Rates (APR) between 2.25% and 3.50% with discounts.1 Although averages fluctuate, the current APRs for personal lines of credit, for comparison, range anywhere from 6% to 36%. While rates from other lenders may vary based on creditworthiness, First Republic Bank's Personal Line of Credit does not use risk-based pricing.
Beyond the product specifics such as interest rates and loan fees, don't underestimate the value of client service; First Republic Bank's Personal Line of Credit also provides a level of personal service that isn't frequently offered through a traditional car refinance. When you apply for a personal line of credit at First Republic Bank, you'll be matched with an expert who will stick with you through the life of the loan, and who can help you reach your financial goals beyond your current car loan needs.
When you're ready to get started, use this personal line of credit calculator to help you figure out how you can better fund your vehicle and potentially take care of additional financial goals at the same time.
Refinancing a car loan can be an easy way to pay less in interest and less in overall monthly payments over your loan’s life, but there are multiple factors to consider. In some situations — like if you’re near the end of your original loan, you have an older car or there are hefty prepayment penalties associated with your original loan — it might not be worth refinancing.
However, if your financial situation has improved since you got your initial car loan, or you think you may qualify for a lower interest rate, then researching different lenders and reviewing all of your options can help you start saving money as soon as possible — and drive towards your next goal.