How Car Loan Refinancing Works

How Car Loan Refinancing Works


Car loan refinancing can make monthly car payments more affordable by lowering the interest rate or extending the finance term. There are pros and cons to refinancing a car loan, however, so it’s important to understand what’s involved.  

Here, we take you through how refinancing a car works, the benefits and drawbacks, and whether it might be right for you. 

How does car loan refinancing work? 

Refinancing a car loan is when you take out a new loan to repay an existing finance arrangement. The money from the new loan pays off the existing loan, and a fresh contract comes into force with new terms and repayments. These repayments will typically be less than your original finance deal due to lower interest rates, or perhaps a longer contract. This might be a hire purchase agreement, for instance, or a Personal Contract Payment (PCP).  

Related: Hire Purchase Vs PCP Budgeting Guide

Pros and cons of refinancing a car

Of course, ideally, no one would have to refinance their car but there are positives and negatives to refinancing. 

For example, a pro of refinancing a car at the end of a PCP agreement could cover the cost of the large final payment. 

Another major advantage of refinancing a car loan is that the new loan has a lower interest rate, so ultimately it will be cheaper. 

FInally, if you are struggling with your monthly repayments then refinancing and extending the car loan can reduce your monthly repayments to a more manageable amount. 

On the other hand, there are cons to refinancing a car. The major negative to mention is that sometimes you might end up paying more for your car overall. 

This means the downsides also need to be carefully considered before going ahead, so how can refinance affect you financially? 

Does Refinancing A Car Hurt Your Credit?

Yes, refinancing a car loan can negatively affect your credit as each time you apply, a ‘hard' credit check is carried out which ends up on your permanent credit record. Credit lenders will look at this when you are applying for other loans in the future.  

Credit score 

When you take out some forms of borrowing, the lender carries out a ‘hard’ credit check. They use the information in your credit file to determine the level of risk they’re taking on by lending to you. Each time this type of check is made, it’s registered on your credit record and can affect your ability to obtain other borrowings, such as a new credit card.  

Car loans and the potential for negative equity 

Negative equity means that you owe more money to the lender than the car is worth. As refinancing typically involves a longer period to pay for the car, you could potentially reach a point of negative equity.   

What are the alternatives to car refinancing?

With the potential drawbacks of car refinancing in mind, are there any other options if you don’t want to start a new PCP or hire-purchase contract?  

Personal loan 

A bank personal loan would pay off your car finance agreement. If the interest rate and other terms of lending are right, you wouldn’t need another hire purchase agreement and could repay your car at a fixed rate over the time offered by your bank. 


If you have significant savings you might choose to use some of them to repay your car, rather than to refinance. It’s important to add that an emergency fund is very useful, and would help you avoid going into debt unexpectedly. This is why it’s advisable to retain some savings for this purpose if possible.  

Formal repayment plan for other debts 

If you’re in serious financial difficulty and can’t keep up with other repayments as well as your car finance, you may be able to pay off the credit card and other unsecured debts within a formal debt payment plan. This is called an Individual Voluntary Arrangement (IVA) and could free up more money to make your car repayments so that you don’t have to refinance. 

Now we’ve gone through how car refinancing works, and the pros and cons/potential effect on your finances, what is the process of refinancing your car? 

How to refinance your car with bad credit

Refinancing a car loan with bad credit in the UK can be a challenging process, but there are a few steps you can take to improve your chances of success. 

Step 1: Make sure refinancing is right for you 

  • Consider the age of your car – if it’s an older model you may not qualify for new finance 
  • Early settlement fee – if the original lender charges an early settlement fee you need to check whether the benefit of any savings is cancelled out. The same applies to fees that the new lender may charge. 
  • Are you struggling financially? If so, defaults on your credit file could disqualify you from refinancing. 

Step 2:  Obtain a copy of your credit report 

  • Check your credit score with all three UK credit reference agencies – Experian, Equifax, and TransUnion. If it’s not as high as you’d like, you might want to consider building it up a little more before applying for car refinance.   
  • Your ‘credit utilisation ratio’ is an important factor that lenders look at when sanctioning borrowing. This is the amount of credit you’re using when compared with the amount available to you. If it’s relatively low, your credit score will be better. 

Step 3: Supporting documentation for your application 

  • The new lender will need to see proof of identification and proof of your income to support the application, along with the existing loan agreement. You’ll also need your vehicle registration document and proof of insurance. 

Step 4: Check all the details 

  • Before you agree to the refinancing deal, you should double-check that all the terms and conditions are correct, including the repayment amount and duration of the loan. 

Step 5: Sign on the dotted line 

  • Sign for your car refinances if you’re happy that everything has been checked and is in order. The car dealer/lender should have let you know the first and subsequent repayment dates and amounts, as sometimes the first repayment can differ.  

Is car refinancing right for you? 

Refinancing your car can make a considerable difference to monthly outgoings if you secure a lower interest rate or a longer term. With the cost of living rising so steeply, it may also make priority payments, such as mortgage/rent and utilities, easier to manage.  

It’s essential to be aware of the drawbacks too, though, so you know exactly what refinancing a car means in practical terms. This allows you to make an educated decision that benefits you and your finances. 

Bumper can also help to ease your financial situation with our interest-free car repair loans. Split the cost into interest-free monthly repayments, at thousands of repairers nationwide.

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