How to refinance a car with example

What is car refinancing?

Car refinancing refers to taking out a new finance agreement to pay the outstanding balance of an existing car loan, often with a different credit provider.

Just as with the previous loan, with a refinanced car loan, your car will be used as collateral.

Advantages of refinancing your car loan

• You may be able to secure a lower interest rate, which will reduce the overall amount of interest you’ll pay on the loan.

• Many finance providers offer flexible repayment terms, which can be tailored to suit your personal circumstances.

• You might also be able to reduce your monthly payments, allowing you to manage your budget more effectively.

• Conversely, if your financial circumstances improve, you may be able to pay off your loan earlier by refinancing it and reducing the duration. Whilst your monthly payments are likely to increase, you should pay less interest overall.

• If you’ve bought a car on a Hire Purchase (HP) or Personal Contract Purchase (PCP) deal, you won’t own the vehicle until the loan is paid off in full. However, you could take out a personal loan to pay off your finance deal. Although you’ll be liable to pay off this new loan, you’ll now own your car.

• Some finance providers offer cash-out refinancing loans, enabling you to refinance the original loan and borrow money to cover other expenses. However, this option is usually reserved for those who have a considerable amount of equity in their vehicle.

Challenges and considerations for refinancing

• A higher interest rate means that borrowing costs are typically higher than in previous years.

• In December 2021, the interest rate in the UK was just 0.1%, but the Bank of England voted to increase it at the next 14 consecutive meetings, until it reached the current rate of 5.25% in August 2023.

• On March 21st 2024, the Bank of England voted to retain the current interest rate of 5.25% for the fifth time in a row.

• You may have to make early settlement compensation payments if you choose to pay off a car loan early. This could be equivalent to up to two months’ worth of interest. When setting these fees, credit lenders must follow the Consumer Credit Act (CCA).

• If you refinance a car loan for a longer term, you’ll probably pay more in interest over the length of the contract. Therefore, you should consider whether lowering your monthly payments would be worth paying more over a longer period.

• If you are in negative equity (or owe more on your car than what it’s worth), securing a refinance loan can be difficult. If you do manage to get approval from a lender, they may charge you a higher rate of interest.

• According to the Consumer Credit Act, a lender cannot repossess your vehicle without a court order, if you have paid over a third of the total amount payable.

• You also have the right to voluntarily terminate the agreement and hand back the vehicle once you have paid 50%.

• However, if you have one or both of these protections and then refinance your car loan, you will lose them until you reach the payment thresholds once again.

Example of refinancing a car

Many banks allow customers to refinance their car loans. Here’s how it usually works:

• Provide the bank with details about your car and your current finance deal. Ask your current provider for a settlement quote to ensure this information is as accurate as possible.

• Wait for a decision from the bank. You can often find out whether you’re approved within minutes.

• Email the settlement figure to the bank to switch over to them.

Hire Purchase (HP) refinancing: Representative example

• You could borrow a total of £13,000 over 48 months, with 48 monthly repayments of £306.05.

• The total repayable amount would be £14,700.40 (including a £10 purchase fee).

• The representative APR is 6.3% and the annual interest rate is fixed at 6.09%.

Source: Lloyds Bank

Please note: Interest rates and other costs may vary depending on your chosen bank and personal circumstances. Contact your bank for a personalised quote.

Is refinancing the right choice for you?

Before deciding whether car refinancing is right for you, you should consider the following factors:

• Your current interest rate: Look at the interest on your current car loan and compare it to the refinancing rates offered by other lenders. If you can secure a significantly lower rate, refinancing your car could be beneficial.

• Your credit score: Lenders will take your credit score into account when deciding whether to accept your application for refinancing. If your credit score has improved since you took out the original loan, you may qualify for a lower interest rate. However, if it has fallen, you may struggle to get a favourable refinancing deal.

• Additional fees: Refinancing your car may come with additional fees such as application and appraisal fees. You may also be liable for a prepayment penalty.

• Length of the repayment term: It’s important to think about the optimal repayment term length in relation to your financial circumstances. If you choose a longer term, your monthly payments will be lower, but you’ll pay more interest over the duration of the loan. However, if you wish to reduce the term of the loan, you’ll need to ensure that you can afford the higher monthly repayments.

• Equity: If you’re in positive equity (i.e. if the car’s value exceeds the amount owed), you are in a good position to refinance your car. However, if you are in negative equity (meaning the amount you owe exceeds the car’s value), you may have difficulties finding a lender who will refinance your loan – and if you do, your monthly repayments may be higher.

The refinancing process explained

Want to refinance your car? We’ll explain the process to follow in the step-by-step guide below:

• Check your credit score: Before you apply to refinance your car, check your current credit score. Lenders will typically check your credit score when considering your application. If you have a poor credit score, this may limit your refinancing options.

• Calculate how much you’ll save: A quick online search will show you a variety of car refinancing calculators. These tools can help you work out how much you could save by refinancing your motor and decide whether this avenue is worth pursuing.

• Explore the market: Don’t commit to the first lender you see – there may be better offers out there. Compare a few quotes to decide which option best suits your needs.

• Review prospective lenders carefully: Before making the switch to a new lender, pay attention to their online reviews and ratings.

• Make sure you understand the terms: You should read the terms of the loan carefully before signing – and if there’s anything you don’t understand, ask for clarification.

• Pay off the original loan: Once your refinancing loan has been approved, the lender will usually pay off the existing one immediately. However, it is prudent to ask for confirmation that the original loan has been paid.

• Start paying off the new loan: Once the new loan is in place, begin making payments according to the terms. You may notice that your credit score initially drops, but it should stabilise (and gradually improve) so long as you reliably make the payments.

• Keep an eye on your credit score and your car’s value: As you make repayments on the new loan, monitor how your credit score is affected over time. You should also document how your car’s value changes. Use our free car valuation tool to find out what your motor is worth.

• If your credit score improves or your car’s value increases, you may be able to refinance again with more favourable terms.

What documents do I need to refinance my car?

• Car details: Including the make, model, year and mileage.

• Loan details: You’ll need to provide key details about your current car loan, including the amount you owe, the interest rate – and the remaining term.

• Your personal details, including your name and address.

• Your bank details.

• Proof of identity, address and employment.

Can you refinance a car that’s already on finance?

Yes, if you have bought a car on a PCP or HP agreement, you can refinance your motor with a new provider. Your car will now be used as collateral for this new loan.

Does refinancing hurt your credit score?

Refinancing is likely to hurt your credit score a little at first. When a new account is added to your credit report, this reduces the average age of the accounts on your report. This is likely to reduce your credit score.

However, providing you keep up with the payments, your credit score should recover and then improve over time. By refinancing a car loan, you can reduce your debt and your monthly payments, which lenders will view positively.