How to Refinance a Car Loan With Bad Credit
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More than 60% of lenders that provide auto financing now also offer auto loan refinancing options for drivers with existing car loans.
Individuals wanting to refinance a bad credit car loan that still have a low credit score might be disappointed. Obtaining better interest rates than your existing loan is much more likely when your credit history and credit score have improved.
Can You Refinance Your Car Loan When You Have Bad Credit?
Those with fair or bad credit will need to evaluate whether an auto refinance loan is possible and if it will benefit them. Auto refinancing may allow you to lower interest rates, lower monthly payments, or restructure your loan payments to pay off the debt sooner.
Refinancing a bad credit auto loan is most advantageous when your credit score has improved. This scenario might allow you to replace the current loan with a new loan that has a lower interest rate.
The current auto loan refinances show that average new loans have approximately a 6.3% lower interest rate than current loans. The table below shows how much those with excellent credit can save over a loan term compared to those with bad credit.
Some car buyers are seeking more affordability by maintaining the same current loan term but reducing the amount of the car payment. Others obtain loans with slightly higher monthly payments and lower interest rates, which can shorten the loan term for a faster payoff.
How Credit Scores Impact Lender Auto Loan Rates ($15,000 Loan)
| FICO Score Range | APR (New Car – 60 mo.) | Total Interest Paid | APR (Used Car – 48 mo.) | Total Interest Paid |
|---|---|---|---|---|
| 720 – 850 | 3.50% | $1,427 | 3.75% | $1,233 |
| 690 – 719 | 5.00% | $1,895 | 5.25% | $1,652 |
| 660 – 689 | 7.25% | $2,917 | 6.75% | $2,249 |
| 620 – 659 | 9.50% | $4,291 | 8.00% | $2,748 |
| 590 – 619 | 12.00% | $5,948 | 10.50% | $4,924 |
| 500 – 589 | 15.00% | $7,635 | 13.50% | $5,919 |
Source: FICO Auto Loan Calculator
1. Check Your Credit Scores and Reports
Begin the auto refinancing process by reviewing your current credit report. Consumers are eligible for a free copy each year through Experian, Equifax, and Transunion, the major credit reporting agencies.
Reviewing your credit score and report details provides you with an accurate assessment of how those who issue refinance loans will perceive you. Look for possible errors that are hindering your credit score and have them corrected before beginning the auto loan refinance process.
The Fair Isaac Corporation (FICO) introduced the FICO credit score model roughly 30 years ago. Today, it has become the standard for how different lenders assess borrowers when deciding to make new loans, refinance loans, set loan rates, and more.
In the years since, FICO introduced several industry-specific models for lenders involved in auto financing, mortgage loans, and more. The three major credit bureaus use the following versions specifically for auto loans:
- Experian: FICO Auto Score 2, 8 and 9
- Equifax: FICO Auto Score 5, 8, and 9
- TransUnion: FICO Auto Score 4, 8, and 9
Be sure to check your existing auto loan terms and conditions for any prepayment penalty that might apply for paying off the loan early. A prepayment penalty might offset some of the potential savings from an auto refinance loan.
2. Shop Around for the Best Option
Today, auto refinance loans are offered by a variety of lenders including banks, credit unions, and online auto loan refinancing companies such as AutoPay and My Auto Loan. Transunion explains that credit unions have the largest market share in the auto refinance market at 60%.
Compare competing auto loan refinancing options on more than simply the monthly payments. For example, read the car loan refinancing offer details closely for loan origination fees and other expenses that apply.
Applying for auto loan financing offers from competing lenders generates multiple recent credit inquiries that may adversely impact your credit score because it creates a “hard pull” entry on your credit report which can be a concern for those with bad credit.
Experian recommends applying for all the auto refinance loans within 14 days, which FICO will typically combine into a single entry.
Check to see if a bank, credit union, or another lender that you have an existing relationship with refinances car loans, as they might be more willing to offer good refinancing rates despite your bad credit.
Just How Bad Is Your Credit?
What is a good credit score to buy a car? There is no standardized ideal minimum credit score for obtaining a car loan, as individual lenders have their own provisions regarding what constitutes a good or bad credit score.
Experian categorizes consumers that are seeking original (initial) car loans as follows:
- Super prime: 781 +
- Prime: 661 to 780
- Near prime: 601 to 660
- Subprime: 501 to 600
- Deep subprime: 500 or below
In looking at the current auto refinance market, the chart below adds additional insight.
Average Auto Refinance Interest Rates
| Credit Score | Lender Rates for Refinancing |
|---|---|
| 750 or more | 3.25% |
| 700 to 749 | 4.00% |
| 600 to 699 | 6.50% |
| 451 to 599 | 9.00% |
Source: Vehicle Refinancing, 2024 Estimates
As the data suggests, borrowers approaching the auto refinance market should prioritize working to improve their credit score because of the financial ramifications.
Would you have an opportunity to lease a car with bad credit instead of pursuing a traditional vehicle loan? Leasing can be summarized as a long-term vehicle rental where the lessee makes monthly payments, usually for a new rather than a used car.
Leasing is unlikely to be a viable option for those with bad credit. Roughly 83% of consumers that obtain a lease have a credit score that exceeds 660.
Ideas for Getting a Better Auto Refinance Rate
The largest single factor that influences your FICO score (35%) is your payment history. Establishing a commitment to making all account payments on time is critical to your long-term credit outlook.
When your credit report contains derogatory entries from your past, there are various ways of making improvements– some of which will follow.
Get a Co-Signer
Having someone serve as a co-signer involves asking an individual with good credit to act as a guarantor, meaning that they would ultimately assume responsibility for the car loan payments if you were unable to do so.
Co-signers are often either immediate family members or close friends, as they are exposing themselves to potential risk if you fail to satisfy the financial obligations.
It is important to differentiate a co-signer from a co-applicant or other joint ownership arrangements. A co-signer does not formally assume ownership rights on the vehicle; rather, they function as more of a “form of insurance” which lessens the lender’s perceived risk.
Get a Credit Builder Loan to Improve Your Credit
Credit builder loans are a form of installment loan that represents a form of credit distinct from mortgage loans, personal loans, or credit cards.
Credit Strong credit builder loans can bolster both a consumer’s credit history and savings significantly. The borrower is provided with a loan; however, the funds are deposited and secured in a newly created savings account.
The borrower then starts making fixed monthly payments on the loan, which are promptly and directly reported to the three primary credit bureaus. In the meanwhile, funds in the bank account will earn interest throughout the term of the loan.
After the loan has been paid off, funds in the savings account are accessible. Credit builder loans have proven to be an effective means of boosting credit scores and the loan activity typically appears on a consumer’s credit report 30 to 60 days after the initial payment.
Pay Down Credit Cards
Those struggling with bad credit are encouraged to more aggressively make payments toward reducing credit cards and other current debts.
Roughly 30% of your FICO score is based on the amount of current debt you currently owe, particularly relative to your available credit.
Credit scoring models make assessments regarding the manageability of a consumer’s debt. One key factor that is calculated is your credit utilization rate, which is expressed as a percentage as follows:
Credit Utilization Rate = Total Current Debt / Total Available Credit
Credit utilization ratios are partly a reason why “maxing out” credit cards are generally discouraged. A good rule of thumb is to strive for a rate of 30% or lower.
Another consideration associated with a consumer’s manageability of debt is your debt-to-income ratio (DTI). DTI is expressed as a percentage that measures the amount of your income allocated to debt each month.
DTI= Total Recurring Monthly Debt / Monthly Gross Income
$1,000 / $3,000 = 33%
Lenders generally prefer a DTI of less than 36% and view borrowers that are inundated with debt as potentially at risk for default.
When a borrower is directing too much income to debts, they generally lack disposable income and are unlikely to have much savings. Here, the consumer is viewed as vulnerable to any expected decline in income such as if they become unemployed.
Dispute Errors on Your Credit Report
A recent Consumer Reports study indicated that an average of 34% of Americans typically find an error when reviewing their credit report. This report suggests an increase compared to a 2012 Federal Trade Commission’s assertion of a 25% error rate.
The major credit bureaus today now have multiple ways for consumers to formally report an error. Be prepared with sufficient documentation if needed, such as identification (E.g. driver’s license) and proof of residency (E.g. bank statement, tax form, or utility bill).
Some of the potential errors that could hinder your credit score include the presence of an account that is not yours, an incorrect account number, or inaccuracies related to a credit account’s balance or limit.
Reviewing your credit report is also helpful in establishing a baseline credit score for tracking your goals so that you can gauge progress as you employ strategies to improve your credit.
Consumers with an existing car loan should consider whether refinancing makes sense. Refinancing may allow for reducing monthly payments, lowering interest expenses, and other standalone benefits.
Smart consumers who are pursuing a more comprehensive overall credit improvement strategy might use auto loan refinancing as one of several tools in a multifaceted plan, such as paying off credit cards, obtaining a credit builder loan, and more.
CreditStrong helps improve your credit and can positively impact the factors that determine 90% of your FICO score.
