When interest rates are at an all-time low, people often try to refinance their existing debt – mortgages, student loans, and even car loans. However, if you have poor credit, refinancing can be tough.
Can you refinance a car loan with bad credit? It can be challenging to get an auto loan refinancing with a low credit score, but there are options.
Here's what you need to know if you're shopping for auto loan refinancing with a 500 credit score or lower.
An auto refinance simply means that you pay off your existing auto loan with a new loan. Some of the potential benefits of refinancing your car loan include:
Car loan refinancing might make sense if you can save money or free up some room in your budget to pay off other high interest debts.
But with a bad credit history, that might be tough to do.
If your score is in the 300 to 579 credit score range– a "Very Poor" credit rating according to the FICO credit scoring model – you're only eligible for a subprime or even deep subprime auto loan rate.
According to Car and Driver:
"While no lenders have exact cutoffs for considering someone a subprime borrower, the term typically applies to those with credit scores ranging from 550 to 650. . . If you have a score below 550, you'll be in the deep subprime category."
But what does that mean in terms of interest rates?
According to Experian's State of the Automotive Finance Market, the average loan rate on a used car for a borrower in the deep subprime category is 20.67% or 17.78% for a borrower in the subprime category.
By comparison, borrowers in the prime category see interest rates of 6.05% on average.
Interest rates can make a big difference in the size of your monthly car payment and the total interest you pay over the loan's life. To qualify for the lowest auto loan rate, you typically need excellent credit.
If your current loan's interest rate is higher than the rate you might qualify for in a refi, it makes sense to at least consider auto refinancing.
Say the balance on your existing car loan is $10,693, your current interest rate is 20%, your current monthly payment is $397, and you have 36 months left on your 60-month car loan.
You shop around and receive an offer to refinance your current car loan at 16% for 36 months. When you plug these numbers into an Auto Loan Refinance Calculator, you get the following results:
|Current Loan||New Loan||Difference|
|# of Payments Remaining||36||36||-|
By refinancing your auto loan, your monthly payment would drop by $45. And since you're not extending your loan term, you would save $961 in interest over the next three years.
Unfortunately, your interest rate isn't the only thing to consider when you refinance car loan with bad credit.
Consider these factors when deciding whether refinancing is the right option for you:
Check with your current lender to see if you'll have to pay a prepayment penalty when you pay off your existing loan early. According to the Center for Responsible Lending (CRL), most subprime auto loan contracts include prepayment penalties.
While the penalty can vary from loan to loan, the CRL says one common penalty costs six months' interest on the loan if the borrower prepays in the first five years (roughly 4-5% of the original loan amount).
If your prepayment penalty is more than what you'd save by lowering your rate, refinancing car loan might not make sense.
It's better to refinance your auto loan early when there are still a lot of payments to make.
That's because you pay more interest in the early years of your loan. Refinancing car loan in the last year or two of a 60-month loan won't make as much of a difference.
If possible, avoid lowering your monthly payments by extending your loan term. If you do that, you could end up paying more in the long run.
Returning to the example above, say you refinanced your existing $10,693 car loan into a 16% rate, but for 60 months instead of 36. Your car loan refinancing results would be:
|Current Loan||New Loan||Difference|
|# of Payments Remaining||36||60||24|
By extending your loan term by an additional two years, you would reduce your monthly payment by $137 per month but end up paying an additional $1,291 in interest over the next five years.
You also have a greater chance of becoming "upside down" on your car loan, meaning you owe more on the car loan than the vehicle is worth.
This can be risky for two reasons:
Read the loan agreement carefully before refinancing from your old loan so you know exactly what you're signing up for.
The fees to refinance an auto loan should be minimal.
Depending on your state's rules, there may be a fee to change the lienholder on the title or re-register your new loan with the department of motor vehicles, but those fees should be negligible.
Still, it's a good idea to make sure you understand any fees involved to ensure they won't cost more than you'd save by refinancing.
Some lenders try to sell you add-on products like extended warranties or extra insurance when you refinance your car. These can tack on thousands of dollars to your loan, so don't buy them if you don't want or need them.
Despite the potential pitfalls of refinancing listed above, it's not a bad idea to consider a refinance to save money.
Refinancing an auto loan isn't nearly as complicated as refinancing a mortgage.
In general, all you need is:
The lender will also run your credit to check your score.
Since it doesn't take an enormous amount of time or paperwork, it might be worth it to shop around and see what sort of offers you get.
Some options for refinancing include:
Your current lender may be willing to refinance your loan if your loan is in good standing, your credit score has improved since you originally took out your loan, or interest rates have gone down.
Credit unions are not-for-profit organizations that provide traditional banking services for their members. Because they typically operate to serve their members (rather than return a profit to shareholders), they usually offer lower fees and interest rates than banks.
Talk to an agent within the branch to determine whether you qualify and get an idea of the rate you're eligible to receive.
Several online lenders offer auto refinancing to people with bad credit, including:
Shopping around to compare offers can help ensure you get the best rate and terms.
Just remember that when you apply for a new loan, the lender will conduct a credit inquiry, which can take a few points off of your already low credit score.
However, shopping around with a few lenders won't harm your credit score any more than if you'd applied with just one – as long as all of the hard inquiries happen within a short period.
For that reason, you might want to save your refinancing for a week or two when you have plenty of time available to shop around and compare offers.
While there are no guarantees that you'll be able to lower your interest rate, you may be able to refinance your auto loan with bad credit.
Just don't forget to run the numbers to ensure you've considered all potential costs, and the refi will actually save you money.
If you can't get a good offer initially, you might want to work on improving your credit score, ask a friend or family member to be your cosigner, or consider getting credit builder loan. This will give you a better chance of getting approved or help you get a better rate.
Need to build your credit? Self provides a step-by-step credit building process that could help you do just that. Learn more at self.inc
Penfed. "How to Refinance a Car Loan". https://www.penfed.org/learn/how-to-refinance-a-car-loan
Credit Karma. "When does refinancing a car loan make sense?". https://www.creditkarma.com/auto/i/refinancing-car-loan
Janet Berry-Johnson is a Certified Public Accountant and freelance writer with a background in accounting and insurance.