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Dealing with debt can be a very stressful experience and make you feel as if you’ll never be able to pay off what you owe. If you find yourself struggling to manage multiple debts, the snowball method can provide a practical and effective strategy to regain control of your financial situation. This method, popularized by personal finance expert Dave Ramsey, focuses on paying off debts in a specific order to build momentum and motivation.

Read on to learn how the snowball debt payoff method works, including its benefits, plus alternative payoff strategies you may want to consider.

Building the Snowball

With the snowball method you list your debts from smallest to largest based on balance and regardless of interest rates. The goal is to pay off the smallest debt first while making minimum payments on other debts. Once the smallest debt is paid off, you roll the amount you were paying towards it into the next smallest debt, creating a “snowball effect” as you tackle larger debts.

Getting rid of the smallest debt first can give you a psychological boost. If, by contrast, you were to try to pay down the largest debt first, it might feel like throwing a pebble into an ocean, and you might simply give up before you got very far.

A Word About Paying Off High-interest Debt First

From a purely financial perspective, it might make more sense to first tackle the debt that comes with the highest interest rate first, since it means paying less interest over the life of the loans (more on this avalanche approach below).

However, the snowball method focuses on the psychological aspect of debt repayment. By starting with the smallest debt, you experience quick wins and a sense of accomplishment right away. This early success can then motivate you to continue the debt repayment journey. In addition, paying off smaller debts frees up cash flow, allowing you to put more money towards larger debts later.

Recommended: How to Get Out of $10,000 in Credit Card Debt

Making Minimum Payments Doesn’t Equal Minimum Payoff Time

While you may feel like you’re making progress by paying the minimum balance on your debts, this approach can lead to a prolonged payoff timeline. The snowball method encourages you to pay more than the minimum on your smallest debt, accelerating the repayment process. Over time, as you pay off each debt, the amount you can allocate towards the next debt grows, increasing your progress.

The Snowball Plan, Step By Step

Here’s a step-by-step guide to implementing the snowball method.

1. List all debts from smallest to largest. You want to list them by the total amount owed, not the interest rates. If two debts have similar totals, place the debt with the higher interest rate first.

2. Make minimum payments. Continue making at least minimum payments on all debts except the smallest one.

3. Attack the smallest debt. Put any extra money you can towards paying off the smallest debt while still making your payments on others.

4. Roll the snowball. Once the smallest debt is paid off, take the amount you were paying towards it and add it to the minimum payment of the next smallest debt.

5. Repeat and accelerate. Repeat this process, attacking one debt at a time, until all debts are paid off.

A Word About Principal Reduction

It’s a good idea to reach out to your creditors and lenders and find out how they apply extra payments to a debt (they don’t all do it the same way). You’ll want to make sure that any additional payments you make beyond the minimum are applied to the principal balance of the debt. This will help reduce the overall interest you pay and expedite the debt payoff process.

Recommended: Personal Loan Calculator

Perks of the Snowball Method

The snowball method offers several advantages:

•   Motivation and momentum The quick wins and sense of progress provide motivation to continue the debt repayment journey.

•   Simplification Focusing on one debt at a time simplifies the process, making it easier to track and manage.

•   Increased cash flow As each debt is paid off, the money previously allocated to it becomes available to put towards the next debt, accelerating the payoff timeline.

Alternatives to the Snowball Method

While the snowball method has proven effective for many, it’s not the only debt repayment strategy available. Here are three alternative methods you may want to consider.

The Avalanche Method

The avalanche method involves making a list of all your debts in order of interest rate. The first debt on your list should be the one with the highest interest rate. You then pay extra on that first debt, while continuing to pay at least the minimum on all the others. When you fully pay off that first debt, you apply your extra payment to the debt with the next highest interest rate, and so on.

This method can potentially save more on interest payments in the long run. However, it requires discipline and may take longer to see significant progress compared to the snowball method.

The Debt Snowflake Method

The debt snowflake method is a debt repayment method you can use on its own or in conjunction with other approaches (like the snowball or avalanche method). The snowflake approach involves finding extra income through a part-time job or side gig, selling items, and/or cutting expenses and then putting that extra money directly toward debt repayment. While each “snowflake” may not have a significant impact on your debt, they can accumulate over time and help you become free of high-interest debt.

Debt Consolidation

If the snowball, avalanche, or snowflake methods seem overwhelming, you might want to consider combining your debts into one simple monthly payment that doesn’t require any strategizing. Known as debt consolidation, you may be able to do this by taking out a personal loan and using it to pay off your debts. You then only have one balance and one payment and, ideally, a lower interest rate, which can help you save money.

Often called debt consolidation loans, these loans provide a lump sum of cash, usually at a fixed interest rate and are repayable in one to seven years.

Recommended: How Refinancing Credit Card Debt Works

The Takeaway

The snowball method offers a practical and motivational approach to paying down debt. By starting with small debts and building momentum, you can gain control of your finances and work towards becoming debt-free. It can be a good way to take action and commit to a debt repayment strategy. If it doesn’t suit you, you might consider the avalanche or snowflake method or a personal loan to consolidate debt.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

What is the snowball method of paying down debt?

With the snowball method of paying down debt, you prioritize paying off the smallest balance first, no matter what its interest rate is. Once that debt is paid off, you prioritize the next smallest debt.

What is the disadvantage of using the debt snowball method?

The disadvantage of the debt snowball method is that, by prioritizing the lowest amount of debt, you may not be paying off the debt with the highest interest rate first. This means your most expensive debt could continue to grow as you pay off smaller debts.

What is the advantage of the debt snowball method?

By tackling the smallest debt first, regardless of interest rate, you can get a psychological boost from successfully paying that off and then build momentum for getting rid of your other debt.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOPL-Q225-103

Debts fall into two broad categories: secured debt and unsecured debt. Though both types of debt share some similarities, there is one key difference. Secured debt is backed by collateral, and unsecured debt isn’t.

It’s important for borrowers to understand how secured and unsecured debt work. That’s because the type of debt you choose could impact such things as loan terms and interest rate and whether you can get credit. What’s more, knowing the difference between these two types of debt can also be one tool to help you determine the order in which you’ll repay the debt.

What Is Secured Debt?

Secured debts are backed, or secured, by an asset, such as your house. This asset acts as collateral for the debt, and your lender is what is known as the lien holder. If you default on a secured debt, the lien gives your lender the right to seize the asset and sell it to settle your debt.

Mortgages and auto loans are two common types of secured debt. A mortgage loan is secured by the house, and an auto loan is secured by the vehicle. You may also encounter title loans, which allow you to use the title of your vehicle to secure other loans once you own a car outright.

What Are the Possible Benefits of Secured Loans?

Because lenders can seize an asset to pay off the debt, secured loans are considered less risky for the lender than unsecured loans. “Low risk” for a lender can translate into benefits for borrowers. Secured loans generally offer better financing terms, such as lower interest rates.

Secured loans may also be easier for borrowers to qualify for. For example, secured loans may have less stringent requirements for credit score compared to unsecured loans, which generally rely more on the actual credit and income profile of the customer.

What Are the Stakes?

The stakes for borrowers can be pretty high for secured loans. After all, consider what happens if you stop paying these debts. (Timeframes for secured loan default can vary depending upon the type of secured debt and lender terms.) The bank can seize the secured asset, which might be the house you live in or the car you need to drive your kids to school or yourself to work.

Failing to pay your debt, or even paying it late, can possibly have a negative effect on your credit score and your ability to secure future credit, at least in the shorter term.

What Is Unsecured Debt?

Unsecured debt is not backed up by collateral. Lenders do not generally have the right to seize your assets to pay off unsecured debt. Examples of unsecured debt include credit cards, student loans, and some personal loans.

What Are Some Benefits of Unsecured Loans?

Unsecured loans can be less risky for borrowers because failing to pay them off does not usually result in your lender seizing important assets.

Unsecured loans often offer some flexibility, while secured loans can require that you use the money you borrow for very specific purposes, like buying a house or a car. With the exception of student loans, unsecured debt often allows you to use the money you borrow at your discretion.

You can buy whatever you want on a credit card, and you can use personal loans for almost any personal expense, including home renovations, buying a boat, or even paying off other debts.

Recommended: Typical Personal Loan Requirements

What Are the Stakes?

Though unsecured loans are less risky in some ways for borrowers, they are more risky for lenders. As a result, unsecured loans typically carry higher interest rates in comparison.

Even though these loans aren’t backed by an asset, missing payments can still have some pretty serious ramifications. First, as with secured loans, missed payments can negatively impact your credit score. A delinquent or default credit reporting can make it harder to secure additional loans, at least in the near future.

Not only that but if a borrower fails to pay off the unsecured debt, the lender may hire a collections agency to help them recover it. The collections agency may continually contact the borrower until arrangements to pay are made.

If that doesn’t work, the lender can take the borrower to court and ask to have wages garnished or, in some extreme cases, may even put a lien on an asset until the debt is paid off.

Managing Secured and Unsecured Debt

Knowing whether a loan is secured or unsecured is one tool to help you figure out how to prioritize paying off your debt. If you’ve got some extra cash and want to make additional payments, there are a number of strategies for paying down your debt.

You might consider prioritizing your unsecured debt. The relatively higher interest typically associated with these debts can make them harder to pay off and could end up costing you more money in the long run. In this case, you might consider a budgeting strategy like the avalanche method to tackle your debts, whereby you’d direct extra payments toward your highest-interest rate debt first. (Be sure you have enough money to make at least minimum payments on all your debts before you start making extra payments on any one debt, of course.)

You can also manage your high-interest debt by consolidating it under one personal loan. A personal loan can be used to pay off many other debts, leaving the borrower with only one loan — ideally at a lower interest rate. Shop around at different lenders for the best rate and terms you can find.

However, it can be smart to be cautious of personal loans that offer extended repayment terms. These loans lengthen the period of time over which you pay off your loan and may seem attractive through lower monthly payment options. However, choosing a longer term likely means you’ll end up paying more in interest over time.

Recommended: How to Apply for a Personal Loan

The Takeaway

Secured debt is backed up by collateral, such as a house. Unsecured debt doesn’t require collateral. The type of debt a borrower chooses may impact things like the cost of a loan and whether they can get credit. It can also help determine the order in which debt is repaid. Since unsecured loans could have higher interest rates or fees, you may decide to consider prioritizing paying down that debt first. Consolidating high-interest debt under one personal loan, ideally at a lower interest rate, is another strategy.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

What is an example of an unsecured loan?

An example of an unsecured loan would be an unsecured personal loan. In this case, your financial credentials are evaluated when you apply, but you don’t have to put up an asset as collateral to obtain the loan.

Is it better to get an unsecured or secured loan?

This decision depends on your needs and your situation. A personal loan can be faster to obtain and typically doesn’t require collateral, but the interest rate may be higher than what you would be offered for a secured loan, in which you put up collateral and likely face a longer path to approval.

What’s the difference between a secured and unsecured loan?

With an unsecured loan, you don’t have to put up collateral. With a secured loan, you do, such as using your house as collateral for a home equity loan. Typically, secured loans are seen as lower risk to lenders and therefore have lower interest rates.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOPL-Q225-098

Refinancing an auto loan can be a smart financial move if you’re looking to lower your monthly payments, secure a better interest rate, or adjust the terms of your loan. Whether you’ve built your credit score, interest rates have dropped, or you simply want to free up cash flow, refinancing can provide potential savings over time.

It’s important to understand the auto loan refinancing process, from checking your eligibility to comparing lender offers and submitting an application.

Here, we’ll walk you through the steps to refinance your auto loan, helping you determine if it’s the right choice for your financial situation.

What Is Auto Loan Refinancing?

Auto loan refinancing is the process of getting a new loan to pay down the balance of an original car loan. That all takes time, effort, and money (for the loan applications and servicing fees), so you should be sure you have a good reason before you go to the trouble of taking out an auto refinancing loan.

Ideally, your car is holding its resale value. If your car’s value is lower than what you owe on it, refinancing may not be a good option. Older cars could be problematic because no matter how well you’ve maintained it, a car depreciates in value over time.

What’s also important is to understand how to refinance an auto loan. If you extend your loan term or take cash out of your equity, you could wind up owing more than what your car is worth. This is called being upside down on your car loan. If you have to sell the car, you’ll need to pay the lender the difference. Clearly, this is to be avoided.

How to Refinance an Auto Loan

With refinancing, just as with your original deal, there are very particular car loan requirements.

Once your application is approved, your new auto loan provider will pay off your old auto loan or give you the funds to do so and become your auto loan manager. Future payments will go to the lender who handles your refinanced loan.

8 Tips for Refinancing an Auto Loan

These tips on how to refinance a car loan will help you avoid the pitfalls and ensure the process goes smoothly.

1. Compare Your Options

The first step is to list everything you desire from the new loan. It could be a lower monthly payment, a better interest rate, no or low fees, a streamlined application process, or solid customer service.

Now take a look around. You can start with the bank you already use for other services. Some financial institutions offer discounts on interest rates for their customers. Compare the rate offered by your current bank with rates from other lenders. Some people like to get prequalified with at least three lenders for comparison’s sake.

As you survey the refinancing landscape, remember that you may want to prioritize online auto loan refinancing options, since they tend to have fewer fees and competitive rates.

2. Determine When the Right Time Is for You to Refinance Your Car Loan

Figuring out when you should consider refinancing a car is key. People pursue a refinance for all kinds of reasons, including:

To Get a Lower Interest Rate

One of the chief benefits of refinancing a car is that the owner saves money over the life of the loan through a reduced interest rate. Take a vehicle for which the original loan was $25,000 and the refinance loan is $21,000. For a 60-month loan where the interest rate is cut from 7% to 5%, for example, the refinancing could save approximately $6,000 over the life of the loan.

To Shorten the Loan Term

Car owners who are cash flush may shorten their auto loan terms to pay off the car faster, thus saving significant cash with less paid in interest over the life of the loan.

To Extend the Loan Term

Car owners who need some financial breathing room after a job loss, an injury or illness, or a divorce or other family issue can extend the term of the loan to reduce the monthly (but not overall) loan costs.

To Get Some Extra Cash

If you have enough equity in your car, you might be able to take out a refinance loan that’s more than what you owe, known as a cash-out car refinance. But realize that if you opt for this kind of refinancing, you will still have to pay back both the car loan and the extra money.

Recommended: Smarter Ways to Get a Car Loan

3. Get the Paperwork Ready First

Before applying for an auto loan refinance, it’s best to be prepared. Documents you may need include:

Original Auto Loan

Lending institutions will require the original loan paperwork to process a new loan. The original loan paperwork should include the loan amount, the monthly payment, the interest rate, the payoff number, and the up-to-date loan balance.

Vehicle Information

Auto loan providers will also ask for your current vehicle information. This document should include the vehicle’s make, model, year, mileage, and vehicle identification number.

Auto Insurance Paperwork

Make sure you have your car insurance records, including type of insurance and the amount of the insurance included in the policy. Auto lenders won’t make a loan to an uninsured or significantly underinsured vehicle owner. That’s because the lender has a stake in the vehicle, as well. If the car is damaged or totaled, your lender will want to know it was properly insured.

Employment Records

Your auto loan refinancing lender may also ask for proof of income and employment to ensure you have the means to repay the loan.

Personal Information

In addition, a typical auto refinancing loan application likely includes the following:

•   Name

•   Date of birth

•   Email address and phone number

•   Address

•   Social Security number

•   Driver’s license number

•   Work status

•   Your bank’s name and info

4. Pay Attention to the Details

Before green-lighting an auto loan refinancing deal, you need to know the exact costs. Make sure to nail down how much you’ll save per month and, even more importantly, over the life of the loan. With an older vehicle depreciating in value, refinancing might not be the wisest course.

Watch out for fees. Auto refinancing can carry with it costs ranging from the application fee to title transfer fees, which can eat up savings. Not all lenders will charge significant fees, which is why it’s important to shop around.

5. Prepare for a Hit on Your Credit Score

Refinancing an auto loan, like any other kind of refinance, has the potential to lower your credit score temporarily. This is because it usually requires a hard pull credit check, and also the fact that you are replacing an older loan with a newer one.

When you apply for loans, each lender you apply with will request a credit check that causes a hard inquiry to be entered on your credit report. This can cause a small reduction in your credit score. If you qualify for and accept a loan offer, you’ll typically see another score dip.

Remember, prequalifying for the loan you’re interested in can reduce the number of hard inquiries.

Recommended: Does Financing a Car Build Credit?

6. Have a Backup Plan

What if you found a refinance deal you really wanted, applied, but were declined? You could consider applying through a different type of lender. Online lenders, for example, are typically easier to qualify for.

Or you could work on building your credit for a year and then applying again. Aside from the foundation of paying your bills on time, you could pay your credit card balances strategically and dispute the problems on your credit report.

7. Talk to Your Lender

Another key strategy for refinancing a car loan: Speak to your current lender, as you can refinance with the same lender. Not all lenders offer refinancing, however, so find out if yours does.

If they do, you’ll still want to shop around and see what other lenders can offer you. Ideally, you’ll want to go with the lowest interest rate and best terms. Be aware, though, that even though your original lender approved you for a loan the first time around, you may still need to provide them with proof of income. They will also likely check your credit to see if anything has changed. As mentioned, a hard credit check will lower your credit score temporarily.

8. Determine the Value of Your Car

Before going ahead with any refinancing deal, you need to know what your car is worth. You can look up your vehicle’s make, model, and year to get an estimate of its value.

If your car is still fairly new and in good shape, and you still owe quite a bit on your current loan, refinancing could help you save money. But if your auto loan is almost fully paid, refinancing may not make sense.

Typical Requirements to Refinance

It might help you improve your chances of finding a good refinance deal by getting familiar with what the lenders are looking for:

Strong Credit Score

Most lenders will expect a minimum refinance credit score from potential borrowers. Typically, a FICO® credit score of 700 or more will get you the lowest loan rates on an auto refinancing loan. That said, there are lenders that are willing to work with those with low credit scores.

History of On-Time Payments

Potential lenders will look at how well you did with paying off your existing loan. If you’ve failed to make payments on time, that won’t help your cause seeking refinancing.

Improvement in Circumstances

Lenders generally like to see an increase in income or some other quantifiable measuring stick that signals you are worth a lower interest rate.

Pros and Cons of Auto Loan Refinancing

Auto loan financing has advantages and disadvantages, and what’s best for you depends on your specific situation. But as you decide whether to move ahead with the process, weighing the pros and cons of refinancing can help.

Pros

•   You may get a lower interest rate, which could save you money.

•   Your monthly payment might be lower by either getting a lower rate or extending your loan term. Keep in mind, though, that extending your term may cost you more in interest over the life of the loan.

•   You could pay off your loan earlier. If you opt for a shorter loan term than the one you currently have, you could pay off your car sooner.

Cons

•   You may need good credit to qualify for the best rates.

•   Refinancing may involve a hard credit check, which can temporarily lower your credit score.

•   There might be additional fees you have to pay, including prepayment fees and origination fees.

Determining If You Should Refinance

Once you’ve studied the pros and cons of refinancing, you need to think about what makes the most sense for you at this stage. Is your debt-to-income ratio low? Is your credit history strong? Do you have a good credit score? If so, you may be able to get a lower interest rate, which could be beneficial. Just check to see what fees may be involved with refinancing to make sure you’ll still come out ahead.

In addition, if your car has a high value and you still owe a decent amount on your current loan, refinancing could save you money if you can get a lower interest rate.

But if your credit is not as strong as it could be, or you currently have a significant amount of debt, refinancing might not be the wisest move for you right now. Refinancing also likely won’t make sense if you are almost finished paying off your current loan. In that case, you may want to stick with what you have.

Recommended: What Should Your Average Car Payment Be?

Applying for Auto Loan Refinancing

If you’re ready to move forward with refinancing, the application process is fairly straightforward. Just follow these steps:

•   Shop around. As mentioned, you’ll want to explore your options with different lenders to find the best rates and terms you can qualify for.

•   Fill out an official loan application. You’ll need to provide personal information, such as details about your employment and income. You may also need to give the lender pay stubs as verification. In addition, the lender will need your original auto loan, your car insurance information, and the make, model, mileage, and year of your car.

•   Wait to see if you’re approved. The lender will review all your information and do a hard credit check. You’ll be notified if you are approved for the loan.

•   Review the loan offer carefully. If the loan offer looks good, sign the loan agreement and keep a copy of the paperwork in a safe place. Often, the new lender will take care of paying off your previous auto loan, but you can check with your original lender to make sure. Then, start paying your new loan, per the terms of your loan agreement.

The Takeaway

Refinancing your auto loan can be a strategic financial move to lower your interest rate, reduce monthly payments, or adjust your loan term to better fit your current financial situation.

However, it’s essential to consider factors such as your credit score, the value of your vehicle, and any potential fees associated with refinancing. By thoroughly evaluating your options and understanding the implications, you can make an informed decision that aligns with your financial goals.

If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.

FAQ

What does it mean to refinance an auto loan?

When you refinance an auto loan, you are applying for a new auto loan and using that new loan to pay off your old auto loan. This gives you a new interest rate, a new loan agreement, and a new loan term.

How do you refinance an auto loan?

To refinance an auto loan, check your credit score, compare lender offers, and gather necessary documents like proof of income and vehicle details. Apply with a lender offering better terms, and if approved, use the new loan to pay off the existing one. Start making payments under the new agreement.

When might you consider refinancing your car loan?

A car loan refinance makes the most sense if you have a good credit score and, ideally, a higher income or some other positive marker than when you got your original car loan. If so, you are more likely to qualify for a lower interest rate and better terms.

Can auto loan refinancing hurt your credit?

When you apply for an auto loan refinance, the lender typically does a hard credit pull, which can lower your credit score temporarily. Your score generally recovers within several months.

Photo credit: iStock/miniseries

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SOALR-Q225-038

Refinancing your car loan can be a smart financial move, but it’s important to know when it’s advantageous and when it might not be the best choice.

Refinancing can lower your monthly payments, reduce your interest rate, or shorten the loan term, potentially saving you money. However, it’s not always beneficial — fees, extended loan terms, or worsening financial conditions can offset the advantages.

Keep reading to learn more about when you should refinance your car, when you shouldn’t, pros and cons of auto loan refinancing, and more.

7 Times When You Should Refinance Your Car

Here are seven situations in which you might want to consider a car loan refinance.

1. When You Can Get a Lower Interest Rate

Interest rates change all the time, especially as the economy rises and falls. Monetary policy from the Federal Reserve may influence consumer loan rates. Refinancing may be right for you if you can lock in a lower interest rate.

Among the pros and cons of refinancing a car is that it may provide you with a lower interest rate (pro), while temporarily causing your credit score to drop due to a hard pull inquiry (con).

Refinancing for a lower monthly payment in some cases may extend your term, and extending your term can saddle you with more interest charges over the life of your loan. An auto loan refinancing calculator can help you see whether a refinanced loan offer may increase or decrease your total interest costs.

2. When You’ve Built Your Credit

Another factor that may change over time is your credit. Credit-building activities (including paying your auto loan on time each month) may help your credit score. This may qualify you for lower interest rates on a refinanced auto loan.

Lenders look at several factors when determining your annual percentage rate of interest and the terms they will offer you. If your credit wasn’t excellent when you got your loan, you might not have gotten the best APR possible. But if you’ve built your credit since then, refinancing could open up better offers.

3. When Your Car Is Worth More Than You Owe

If you’ve kept your vehicle in top-notch shape and perhaps have been aggressive about paying more than you owed each month on the loan, your car could be worth more than the balance remaining on your loan.

If you’d like to take your time paying off the remainder, you might consider refinancing. There are several tips for how to refinance auto loans, such as comparing your options and paying attention to the details.

4. When You Can Pay Your Car Off Faster

Some borrowers may prefer the longest repayment period possible for their auto loans because it means the lowest monthly payment. But those longer-term loans usually have higher interest rates than loans with shorter repayment periods.

If you can afford to make larger monthly payments, you’ll probably pay less in interest and get your car paid in full faster if you can refinance.

5. When You’re Struggling with High Payments

While you may not benefit from lower interest if you refinance over a longer period, it could help if you’re stressing to pay that higher amount each month.

Let’s say you currently have a loan with a term of four years and are paying $500 a month, which is really eating into your budget. Refinancing for a six-year term could drop your monthly payment to, let’s say, $375, so you might gain a little financial breathing room. Just be aware that you might have to pay more in interest over the life of the loan.

6. When You’re Unhappy with Your Lender

If you feel stuck with a lender who isn’t offering great customer service or is otherwise making your business relationship stressful, realize that you may hold the power to walk away by refinancing with another lender.

Before deciding to refinance your auto loan, get familiar with auto loan terminology so you understand things like prepayment penalties, APR, and other terms that you’ll find in the fine print of your current loan agreement.

7. When Your Original Loan Was Through the Dealer

Refinancing may be ideal if you have car loan debt through the dealer. If you signed a retail installment sale contract when buying a vehicle off the lot of a dealership, the dealer may have sold the retail installment contract to a third-party lender, such as a bank or finance company.

This is called indirect financing because it leaves you indebted to a third-party financial institution that didn’t provide you with the auto loan financing directly. Dealerships that arrange indirect financing don’t necessarily arrange the best terms and conditions for you, so exploring your refinancing options may be right for you.

Recommended: Can You Register a Car Without a License?

When Shouldn’t I Refinance My Car Loan?

Just as important as knowing when to refinance a car is knowing when not to do it. It can be tempting when you get those offers in the mail to refinance, but there are a few situations where you shouldn’t. Here are five things to be aware of:

1. When You’re Upside Down on Your Loan

If you owe more on your car loan than the car is worth, refinancing likely won’t help the situation. In fact, many lenders won’t even approve a loan if this is your situation. Your best bet might be to keep chipping away at what you owe.

One way consumers may avoid upside down auto loans is by making a sizable down payment when buying new or used vehicles.

2. When Your Car Is Older

The older your vehicle, the less likely a lender is to approve a refinance. Bank of America, for example, won’t fund loans for cars that are more than 10 years old or have more than 125,000 miles on them.

Why? Cars lose their value so rapidly that an older model may not be worth much by the time you seek financing for it. If you aren’t able to pay your loan, the lender has the right to seize the vehicle, but if it’s not worth much, that right doesn’t do the lender much good.

3. When You Don’t Have Much to Refinance

If you owe less than $7,500, you may have trouble finding a lender who wants to refinance such a small amount. That’s the threshold Capital One, for example, requires for auto refi loans, and other lenders may have similar requirements.

4. When You Bought the Car Recently

Refinancing might not be right for you if you bought your car recently. The value of a new car can plummet immediately once you drive it off of the lot. Unless you’ve made a sizable down payment on the car, your auto loan financing may be underwater when your repayment term begins. As mentioned earlier, refinancing might not be advisable if you’re upside down on your loan.

5. When Your Loan Has Prepayment Penalties

Another time when refinancing might not be right for you is if your existing car loan includes a prepayment penalty clause. A prepayment penalty is a fee that lenders may charge if you pay your loan off early.

Getting a refi loan in some cases may trigger a prepayment penalty. That’s because refinancing pays off your existing loan and replaces it with the terms and conditions of a new financing agreement. You can check your original loan agreement to see whether it includes a prepayment penalty disclosure.

Recommended: Refinance After Repossession

Pros and Cons of Refinancing an Auto Loan

As a consumer, you may ask, “Should I refinance my car?” There’s no easy answer to this question. Your specific situation may determine whether and when to refinance a car loan. Below, we highlight some of the pros and cons of refinancing an auto loan:

Pros of Auto Loan Refinancing

•   May give you a lower interest rate

•   May give you a lower monthly payment

•   May give you a longer repayment term

Cons of Auto Loan Refinancing

•   You may need good credit to qualify

•   It may require a hard inquiry that can hurt your credit score

•   You may pay more interest over the life of your auto refi loan

Does Applying for an Auto Loan Affect Your Credit Score?

Applying for an auto loan can hurt your credit score initially, but it may also benefit your credit score if you make the required car payments on time.

Getting your auto refi loan application approved means a lender will pay off your original loan agreement and replace it with new loan terms. The refinanced loan may feature a lower monthly payment than your original loan.

Applying for auto loans and auto loan refinancing can initially impact your credit score if lenders conduct a hard pull inquiry into your credit report. But know that if you’re shopping around, getting preapproved by multiple lenders may show up on your credit report as just a single inquiry as long as they’re within the same two-week period.

Refinancing a car loan with bad credit is possible, but you probably won’t get a great interest rate. If it’s possible, it might be worthwhile to spend time building your credit so you may qualify for a better rate down the road.

The Takeaway

Refinancing your auto loan could get you a better interest rate, shorten your loan term, or lower your monthly payment, if that’s your goal. However, there are cons of refinancing to consider, too. These include lender fees and possibly paying more in interest over the life of the loan.

If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.

FAQ

When is refinancing an auto loan worth it?

Refinancing an auto loan may be worth it when you’re able to secure a lower interest rate or shorten your loan term. Depending on your circumstances, you may also find it worthwhile to refinance for a longer term and lower monthly payment, even if that exposes you to more interest charges over the life of the auto refi loan.

Can refinancing a car hurt your credit score?

Refinancing can initially hurt your credit score if lenders conduct a hard pull inquiry into your credit report. Hard inquiries may cause your credit score to drop by several points. But refinancing a car may also help your credit score in the long haul if you make required payments on time over the life of your auto refi loan.

When should you not refinance?

It’s best not to refinance a car if you owe more than the car is worth or if the car is more than 10 years old. The auto loan refinancing cost may include a number of fees, such as early termination fees, transaction fees, and title transfer fees.

Should I refinance now or wait?

The urge to refinance now may be strong, but waiting could potentially be a better option for you. Before refinancing your car, look at your credit, then check with lenders to see if you prequalify. If you aren’t able to get a lower interest rate than what you’re already paying, it might be better for you to wait.

Photo credit: iStock/miniseries

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