What is refinancing
Auto loan refinancing is very similar to refinancing for a home loan or student loan. What this means in essence is that you find a new loan for your vehicle to replace the existing auto loan. A few reasons why you may want to refinance your auto loan:
Reduce your monthly car payment
Reduce the total expenditure on interest payments
Get equity (cash) out of the vehicle.
Whatever the reason - refinancing your car used to be a difficult, opaque, and time consuming process until WithClutch. We’ll walk you through some background on why that is as well as every aspect of the refinancing market that helps you better understand the dynamics of why refinancing may be so powerful.
You might have already refinanced a mortgage once before. Refinancing an auto loan has a few more nuances than a mortgage.
The Process to Get Refinancing
The process to get refinancing should be very straightforward but it’s not.
To go about refinancing now you’ll typically go through five steps:
Finding a lender or aggregator
Submitting personal information
Submitting vehicle information
Receiving an Approval / Denial
Producing a series of verification documents
Finalizing loan documents
While the steps seem relatively straight forward, there’s many difficulties in the process.
Step 1: Finding a lender or aggregator
The first step is simply finding a lender or aggregator. 'Who should I refinance with' is fraught with misinformation. Most sources (like Nerdwallet does here) simply point you in the direction of a lender/aggregator without knowing (a) whether you’ll qualify (b) If you qualify whether you’ve been offered a good rate.
Don’t simply apply to everyone - the process will be hugely frustrating. And you’re not interested in just “any loan auto refinancing” you’re interested in the best refinancing option for you. Instead there’s sort of 4 types of companies you could send your loan to:
A loan aggregator: These companies like lendingtree.com or rategenius.com often work with multiple partners, and submit your soft-pull credit application to many lenders to maximize the chance of approval. They’re making money off this service however, so the loans will be slightly marked up.
A large commercial bank: These are common banks like Bank of America, Wells Fargo, or Capital One. These for profit companies often serve near-prime customers, and their rates are most competitive for mid-tier credit.
A Credit Union: These are non-profit institutions that serve to benefit their community members (think Navy Federal Credit Union, or San Francisco Fire Credit Union). Credit unions typically have the best rates for prime borrowers - but few Credit Unions work with below average credit.
A specialty Finance Company: These companies typically work with below-average credit borrows who have credit in need of repair. Finding these companies is typically difficult, and it’s unclear what rates an end consumer may get.
To find your best option - it helps to know your credit score to find 'which type' of lender to go through. Here’s a brief overview of lenders which would best serve each credit tier, and the process to go through.
[TABLE]
Based on these nuances, we even wrote an article about the top 40 auto loan companies most likely to refinance.
Step 2: Submitting personal information
This step is easy and straightforward luckily - you simply enter all your personal details into an online submission form. The only thing to watch out for here is that the site/platform is secure and you can see https:// before the URL structure itself.
Step 3: Submitting Vehicle and Loan Information
The new loan will require the bank to know both about your car, and the old loan you’ve got. You’d think some sort of central database exists, but most often you’ve got to manually enter:
The VIN Number: This 17 digit identifier can be found on the driver’s side door sill, on your vehicle registration or insurance, or in the driver’s side bottom corner of the windshield looking from the outside.
The current Odometer: How many miles you have impacts your value - so you’ll need to enter an accurate odometer statement.
The packages and options on the car: The trim level, and any packages impact the vehicle value too - so don’t forget to enter these. You can use a partner site like KnowMyVIN to find the original window sticker of the vehicle.
Your current loan information: Typically you’ll need to login to your banks website and find:
Current outstanding balance
10 Day Payoff Amount
Current interest rate (APR)
Remaining Payments (time)
Step 4: Receiving an Approval or Denial
After submitting the above, now you’ll get an approval or denial from the lender. A good lender should take less than 15 minutes, but many refinance companies and credit unions take longer (up to 24 hours).
If you’ve received an approval - that’s great, it’s time for next steps. For a denial it's best to understand WHY before moving on. Typically it's due to a few factors (which we can address/talk about later).
The most common reasons for a denial for auto loan refinancing:
The cars LTV is too high
PTI is too high
Credit history is too short
Credit score is too low for the associated lender
Derogatory credit lines are too high
Step 5: Producing the Required Documents
If you’ve been approved - you’ve now got to produce a series of 'proof' documents. This is most likely:
Proof of income (such as a pay-stub, paycheck, or bank statement)
Proof of address (such as a phone, utility, or insurance bill)
ID (such as drivers license or passport)
Loan Payoff Statement
Proof of eligibility (for select credit unions such as church membership
Annoyingly often lenders won’t ask for all these documents at once - so you’ll be sequentially sending documents then receiving requests for another one. Furthermore, which documents are required often depends on your credit score (lower credit scores typically require more proof points).
Step 6: Finalizing Loan Documents
Now it’s time to finalize loan documents. Depending on the lender, you may be able to e-sign contracts online, but many lenders still require “wet-ink” signatures which means you’ve got to send documents back and forth through the mail.
There are 37 states that also have electronic title records and can transfer title purely electronically, the other 13 may require a physical title to be mailed back and forth.
How Dealers Impact Lending Rates and Finance Terms
Unlike home or student loan refinancing, refinancing your car is often subject to even higher interest rate markups for a few reasons:
Most consumers don’t shop auto loan rates outside of the dealership
The dealership is typically paid by a lender
Dealership margins are compressed on the vehicle, so it makes sense to obscure lending rates.
Consumers get over 79% of auto loans directly from the dealership. And although you spent lots of time online discovering what car was priced most cheaply - consumers do far less research on the best priced loan. As a result, auto loan rates are all over the map.
And since lending companies are in the business of 'selling' loans through dealerships, here’s how a typical compensation scheme can work with a dealership:
A dealership can 'markup' a loan interest rate, and collect a portion of this excess interest
A dealership receives a fixed percent of the loan originated (e.g. 1-3% of the loan balance).
In both of the above scenarios dealers have every incentive to get YOU a loan which pays THEM the most. Its rare this loan is the best option for you. Here’s how a dealership might view the loan it could give you on a $25,000 vehicle:
[TABLE]
Which loan would you choose? Which loan do you think the dealer is likely to choose?
Dealers make north of $2,367 on the financing referral and protection products. So if you got your vehicle at a dealership its likely without any other changes you can save money by refinancing the loan.
Protection products as well as the dealer doc fee, taxes and title charges are part of the financing amount and drive the amount you have to borrow. The sum of the vehicle price and those products and fees is the out-the-door price.
We will shed more light on the protection products and how to save money through requesting a refund below - the dealer doc fee we cover in a separate article.
Key Concepts to Understand for Refinancing
(LTV/Loan Payoff/APR/Negative Equity/Credit Score)
To understand a bit how refinancing works, its also important to understand some of the key terms lenders will use. We’ll go briefly into each description below, but there’s plenty of followup reading for each of these topics.
LTV: LTV most simply is the Loan-to-value ratio. As some basic math, think of it as loan balance divided by vehicle value. The natural question is 'what is the vehicle value'. For new cars, this is typically MSRP, for used vehicles it's normally a third party book value (Kelly Blue Book, Black Book, or NADA guide value). We even wrote an article about the top 5 car brands to refinance. LTV is an important metric because it's often used to see how much credit a lender can extend to you.
Payoff Statement: A Payoff statement is the document from your bank which tells you or another lender the total outstanding amount to be paid before the loan is released. Normally the payoff is good only for a limited amount of time (10 days or less).
APR: Annual Percentage Rate is the annual rate of interest charged on the loan. The goal of most refinancings is to reduce this rate.
Negative Equity: Negative Equity simply refers to when the Loan Balance is larger than the value of the vehicle. Think of it this way, if the car has a blue book value of $10,000 and the current loan balance was $12,000 - the car has negative equity of $2,000.
Credit Score: Credit Scores are a system of determining your ability and track record of paying back loans. There used to be a simplified system of credit scoring, but the system has become more and more complicated with multiple credit-scores, and version releases used for different purposes. Some popular names you may hear associated with credit scores are FICO, VantageScore, Experian, TransUnion, Equifax.
VSC: Vehicle Service Contract. This is basically a paid for insurance product that help pay your repair bills should the vehicle require work. Most VSC’s have some minimum payment (deductible) you’ll also need to pay as a part of the repair. Most VSC’s are also financed as part of the original vehicle purchase.
GAP: GAP Insurance is a product that helps pay off your auto loan if your car is totaled or stolen and you owe more than what your auto insurance carrier reimburses you. Its typically also bundled with the original vehicle purchase. Most GAP insurance contracts continue to be paid long after they have any value.
Calculating Savings
To calculate savings from refinancing there’s really two types of savings that are of interest:
Savings on a monthly payment
Total interest savings.
To calculate a monthly payment - we can use the following formula to calculate any given payment:
[FORMULA]
Most of you won’t want to do this, so simply use our auto loan refinance calculator.
In order to find your total interest payments, this formula is fairly easy. Simply multiply your total payments x number of payments to get a total paid amount. Then subtract your original loan amount to get the total interest. Here’s an example below:
Loan Amount = $25,000
Loan Duration = 72 months
Interest = 5.6% APR
Payment = $409.62 per month
Total Interest = [72 months x 409.62 per month] - [25,000] = $4,492.50
Its important to note that you could refinance your loan and have a lower payment but end up paying MORE in total interest. How is this possible? Normally it happens when your remaining payments are over a short time horizon (like 6-12 months remaining on the loan) and you simply extend those payments over a longer time horizon.
How Credit Drives Rates and Lenders
A credit score is meant to be a rough proxy for your “creditworthiness” or your likelihood of paying back a loan. You can read in depth as to how this score is calculated, we’ll cover only the basics here and how it impacts auto loans and auto loan refinancing in particular.
In general a credit score takes into account the following criteria:
Payment history (35%): Whether you’ve paid back previous loans
Amount owed (30%): How much you owed on those loans (a big loan paid back is worth more than a small one paid back)
Length of credit history (15%): How long you’ve been successful at paying back loans
New credit (10%): How often you get new loans or credit lines
Type of credit used (10%): What type of credit you’re using for what purpose (a new credit card is not as important as a mortgage for example).
That credit score is then used to price “risk” which comes in the form of interest rate when it comes to auto loans. In a perfectly efficient world that means the following rule must hold:
Assuming equal income - you would think that implies a customer with a good credit score should always pay less than a customer with a bad credit score.
In auto loans this is NOT the case and the reasons have less to do with credit scoring than dealership and bank incentives. The underlying interest rate is not only a reflection of credit score but also:
Dealership’s ability to markup that loan
Bank willingness to take that loan or customer
Let’s address (1) first. We already covered how dealerships are likely to choose loans which pay THEM the most. That means that each transaction ends up being a negotiation between dealer and consumer. The dealer is attempting to get the loan which pays them the most, which is often not the theoretical best rate for customer.
For (2) there’s some more nuance. When a lender like Capital One works with a dealership they generally are looking for a particular customer profile. Let’s say their downstream investors (who purchase the loans) are pension funds who only want relatively safe loans. In order for Capital One to fund a customer who’s riskier, they may want an even HIGHER premium than the market rate because their buyers would otherwise not want to deal with these customer. That means a given lender’s interest rate could also be expressive of their end customers for their loans.
One other important thing to note about credit scores and auto loans.Credit scores vary a large amount over the course of your auto loan. When you get your auto loan- its simply a moment in time. As you improve your score and make your payments you should be then entitled to a new loan at a lower rate.
Understanding the Market for Refinancing
We talked a little bit how “investors” are the ultimate buyers of these loans. Most lenders end up securitizing loan portfolios into whats called an “asset back security”.
This is probably not important to your loan, but important in understanding how and why your loan may or may not be funded by a particular bank or dealership. When a large bank -- say Ally offers to loan a bunch of money they run into the “expansion issue”.
If Ally has $10B total, that means once they’ve lent out all 10B they must wait for capital to be repaid. If the average auto loan is 72 months, that means starting with $10B they can only loan a new 1.6Bn per year. In order to lend as much as possible, Ally simply sells loan portfolios as a financial instrument.
Here’s how an ABS loan works. This new financial product an “Asset Back Security” (ABS) is really just a contract to pay out the cash flows from loan payments.
Think about it like a series of sequential “cash buckets”, and as an example lets assume we have 100 loans which are all supposed to pay $100 monthly. These 100 loans vary in risk - some are very flaky customers who rarely pay loans back, others have never missed a payment. To make the payment streams more consistent, the cash flows from payback are placed in 4 buckets which investors can buy.
[Bucket of cash flows image]
Bucket 1 (33% of expected cash): This cash flow bucket must be filled first. So even if 75% of loans don’t pay anything back, we expect at least 25 individuals to pay into this bucket. Because its the lowest risk, investors get the lowest returns on this loan tranche.
Bucket 2 (Next 33%): This is a bucket of medium safety. After the first 25 loans have paid back, the 26th loan will begin to compensate investors in bucket 2.
Bucket 3 (Final 33%): This is the riskiest bucket. Sometimes our “flaky” customers don’t pay, and if any customer does pay it first comes out of this cash flow pool. Since this is a high risk bucket, investors have to be compensated a good return.
How GAP and VSC can impact savings rates
We talked about the definition of GAP and VSC earlier - but its also important to note how these products can help you save money on your car loan.
Step 1: Understand that Gap and VSC are overpriced when bought from the dealership. GAP and VSC are typically overpriced from the dealership. Most consumers buy GAP or VSC from the dealership directly. These products are marked up over 100% in most cases (so the warranty you bought for $2,000 only costs $1,000). So even on the first day purchasing your car - its likely you could’ve saved $1,000 or more over the life of the loan.
Step 2: Realize that both Gap and VSC are refundable on a pro-rata basis. Let’s say you bought a VSC that has coverage for 48 months or 50,000 miles for $2,500. If you refinance the vehicle you can actually get the warranty refunded! If you’ve only accrued 12 months or 12,500 miles, you can actually get 80% of the original price back (about $2,000) that will directly reduce your loan balance.
Step 3: If you feel like you still need GAP or VSC, you can still purchase these contract as part of refinancing, but luckily for a much lower price point.
Step 4: Cancel GAP insurance when your car’s loan balance is below its book value. Let’s say you’ve been paying your loan for 3 years and your loan is 7 year. If your car’s loan is now less than the Kelly Blue Book trade in value - than GAP insurance is actually providing NO PROTECTION AT ALL. You’ll happily continuing paying, but the insurance has no material benefit at all - so we recommend you cancel immediately.
[GAP PROTECTION GRAPHIC OVER TIME]
Your Choice of Car could impact your odds of Being Approved for Refinancing
We’ve talked about a couple of important topics with regards to auto loan refinancing and how it works. Now it's time to revisit a decision you’ve already made: what car to buy.
It turns out what car you buy has a huge impact on your likelihood of being approved for refinancing. In fact, we wrote an article about the top 5 cars to refinance. The reason all goes back to our critical LTV metric (Loan to Value). Most lenders will not lend above 140% of LTV for super-prime credit, and often for bad-credit customers that figure can be 80% at most.
Because of these LTV metrics, its likely that cars that hold value better over time are more likely to able to be refinanced. Let’s take an example of two cars a 2016 Toyota Tacoma versus a 2020 Dodge Challenger each purchased for $25,000 and financed over 72 months with a 10.99% APR.
Given the car was the same price - lenders offered the same loans to each customer at the time of the loan. Its how the LTV changes over time that’s interesting.
[Graphic of deprecation for a Toyota Tacoma vs. Dodge Challenger]
As you can see - the loan becomes harder and harder to refinance over time, since the challenger is losing value at rate faster than you can payoff principal. This ensures that a Challenger is materially harder to refinance than a car that keeps its value.
How to refinance your auto loan and save thousands of dollars
Thankfully, we can help you lower your monthly payments. WithClutch.com is a fully digital platform that lets car owners like you do so from the comfort of their own home. No need to set a foot in a bank or credit union. You can lower your rate or get cash in as little as 20 seconds.
Follow three simple steps to refinance your auto loan, get approved in seconds and save thousands in minutes.
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