People often choose to refinance a car loan if they have had a change in their finances and the car payment is now burdensome or if they think they can get a better deal than the terms of their current loan.
If you’ve got some credit challenges, such as missed payments or too much credit or debt, that can drive down your FICO score. The question then becomes if you’ll even be able to refinance a car loan or if you’ll be stuck with your current auto loan instead of enjoying a lower rate through your current lender or a new lender.
Here’s what you need to know.
There is no Minimum Credit Score, But…
Technically, no minimum credit score is required to refinance your auto loan. However, as you might guess, some people are more challenging to refinance than others.
Your FICO score is important, but it’s not the only factor a lender uses to determine your creditworthiness for auto loan refinancing. It is a huge advantage if you have a good credit score and good credit history, not only for approval but to unlock the best interest rates. Anything over 700 will work decidedly in your favor, while a credit score between 660-700 will give you access to standard rates.
You can still get approved for a refinance below 660, but there’s a good chance you’ll pay for the privilege by getting loans with higher interest rates. The best rates are for those who pose minimal risk and don’t have bad credit issues that result in poor credit ratings.
You can offset a lower FICO score with a favorable debt-to-Income ratio (DTI). This indicates that you’re responsible for your budgeting and that you’ll be able to make monthly payments after you’re approved. DTI is expressed as a percentage by comparing the amount of your income to the percentage you’re currently using to pay down existing debts.
Calculate your DTI by dividing your monthly debt payments by your gross monthly income. For example, if your monthly debts are $1,500 and your monthly income is $6,000, your DTI will be 25%.
No minimum DTI will guarantee you qualify to refinance your auto loan. However, you’re more likely to receive favorable terms and a lower annual percentage rate on a new loan with a lower DTI.
Another metric used to determine refinancing suitability is the Vehicle Loan-to-Value ratio. Auto loans are secured loans, meaning you are putting your vehicle up as collateral. If you default on your loan, the lender will repossess the vehicle and sell it to recover the outstanding debt.
That means a lender must know the value of your vehicle vs. the amount of the new car loan you’re seeking. Lenders look for no minimum loan-to-value ratio, but it should always be less than 100%, meaning don’t apply for a $25,000 loan if your vehicle is only worth $18,000.
Income is also another factor. A lower FICO score is less concerning when you can show income greater than $75,000. Lenders interpret this as a higher income makes it easier to afford new debt and are more likely to offer you a lower interest rate as part of the auto loan refinance process.
Other factors a lender considers are:
- The loan amount and whether you’re also paying some down with cash.
- The loan term is important because a longer term can help you get a lower APR while they earn interest over a longer time frame.
- The car’s age is because lenders do not typically refinance vehicles older than ten years.
- If there is a co-signer or co-borrower and what is their credit profile is.
How You Can Improve Your Credit Score
If you want the most favorable terms and the best chance for a refi approval, take these steps to improve your credit score.
Pay down current debts. Reducing the total percentage of your available credit can boost your credit score and improve your DTI.
Make all payments on time. Lenders closely scrutinize your payment history. It may make sense to set up automated payments if you have a habit of forgetting to pay your bills on time.
Check your credit report. Make sure it’s accurate, and dispute anything you disagree with. Request a free copy of your credit report from Experian, Equifax, and TransUnion to ensure you agree with each.
Do not apply for new lines of credit. Every time you apply for any new form of credit such as credit cards or personal loans, it shows up as a hard inquiry on your credit report. Too many of those will result in a temporary credit score reduction.
Have a co-signer or co-borrower. Their credit information will be used to determine creditworthiness and will improve your chances of approval with a better interest rate, indirectly improving your credit score for purposes of loan approval and increasing the chances of lower monthly payments at more competitive rates.
Wait before attempting to refinance. You should wait at least 6-12 months after you buy a vehicle or previously refinanced it before refinancing your vehicle again. This is because it will take a few months for your credit score to rise after a hard credit inquiry with your previous loan.
Shop for loans in a set window of time. When figuring out what kind of loan and interest rates you can get, credit bureaus may count multiple hard inquiries as you seek to prequalify for the same type of loan as just one inquiry if performed within a certain window. This ranges from 15 to 45 days, depending on the scoring method. If you’re sporadic with your applications over several months, you could cause your credit score to drop up to five points for each application.