How Car Loan Refinancing Works

How Car Loan Refinancing Works

If you're ready to make your monthly car loan payments more affordable, car loan refinancing could be the route for you. 

But before you sign up and get started, ensure you're clued in on how car refinancing works. From the pros and cons of refinancing your car to whether it affects your credit score, we answer all the big questions.  So, keep reading! You'll be an expert in car refinancing in minutes. 

What is car refinancing? 

Car refinancing is the process of taking out a new loan to pay off your existing car finance contract.  

This allows you to access a deal with terms that better match your needs. For example, you could lower your monthly payments with a longer-term plan. You could also access a lower interest rate or even take out a loan to pay off a final PCP balloon payment.  

Car refinancing looks different for every driver. But the concept stays the same — to make payments easier! 

How car refinancing works 

First, you'll have to 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 a longer contract. Common options for car refinancing include PCP (Personal Contract Payments) and Hire Payments. 

Related: Hire Purchase Vs PCP Budgeting Guide 

Pros and cons of refinancing a car 

Like all things, there are pros and cons of refinancing a car. If you’re considering this concept, skim the benefits and drawbacks below. These will help you decide if this pathway works for your finances. Research is key! 

Pros of refinancing a car 

  • You’ll pay less interest — If your credit score has improved since buying a car, you might qualify for a lower interest rate. If you secure a lower interest rate, you’ll save enough over future payments to make refinancing a loan worth it. 
  • Pay your loan earlier — Some might have increased income since purchasing the car. Refinancing the car on a shorter term will allow you to pay it off sooner and with less interest. 
  • Lower monthly payments — A pivotal draw to refinancing is lower monthly payments. Lower payments free up more income, allowing you to focus on high-rate debts or savings. Lower monthly payments also make it easier to stay on top of payments. 
  • You can use the equity in the car — Sometimes, you can borrow cash from your car’s equity via refinancing loans. Note that there are limits to this and some significant downsides. It’s best to save this for emergencies.   

Cons of refinancing a car 

  • You could pay more interest — If you end up with a longer contract, you might pay more in interest. This can even happen with a reduced interest rate, as the payments add up over the extra few years of the contract. 
  • Prepayment penalties — Sometimes, there are prepayment penalties for paying off your loan early. Fees differ from lender to lender, so ask yours before signing anything! 
  • You could end up paying more than the car is worth — Refinancing might leave you owing more than the car is worth due to extended contracts and interest payments. 
  • Origination fees — Some lenders also charge origination fees when you choose to refinance. These cover the cost of underwriting, processing, and preparing necessary documents.

Does Refinancing A Car Hurt Your Credit Score? 

Yes, refinancing a car loan can negatively affect your credit score. 

This is because 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, such as a mortgage or business loan. 

Don’t worry if you’ve noticed that your credit score has dropped after applying for a refinancing loan. You can build it back up by keeping on top of your payments, managing other financial commitments, being responsible with credit cards, and getting on the electoral roll. 

Why car refinancing affects your 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 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. 

However, note that applying for car refinance won’t leave your credit score low permanently. There are ways you can boost your score, and making reliable payments is the first step! 

What about car loans and the potential for negative equity?  

You might also be wondering about car loans and 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. This is one of the critical drawbacks of car refinancing. So, take time to think through your decision and do the maths to ensure you don’t end up paying more than is needed. 

What documents do you need to refinance a car? 

Once you’ve applied for car refinancing, you’ll need to gather some important documents. Get these ready before you start to save time and stress in the refinancing process. 

  • Vehicle registration 
  • Copy of your driver’s licence 
  • Proof of income 
  • Proof of insurance 
  • Proof of residence 
  • 10-day payoff statement 
  • VIN (vehicle identification number) 

Comparing refinance offers 

Alongside pondering the pros and cons of refinancing a car, you should compare offers from different lenders. Some lenders allow you to get prequalified without applying. However, others may require a complete credit check before giving personal quotes.  

When comparing offers, look at repayment terms, fees, and interest rates. If in doubt, reach out to the lender for more information. Asking questions is key to getting the best deal for you. 

When does it make sense to refinance a car loan? 

Unfortunately, there’s no one answer to this question. Refinancing a car is a case-by-case decision. But some factors indicate refinancing might be a positive decision for you. 

These include the following: 

  • Your credit score has risen since you entered the contract 
  • Car rates have dropped 
  • Your current loan was through a dealer  
  • You’re struggling to keep up with payments 

When shouldn’t you refinance a car? 

There are also clear signs that you shouldn’t refinance your car. The following circumstances aren’t great for refinancing a car: 

  • Being upside-down (owing more than the vehicle is worth) 
  • Rising interest rates 
  • Owning an older car 
  • Being near the end of the loan term 

What are the alternatives to car refinancing?  

Not sure if car refinancing is the route for you? Check out these alternatives before you make a commitment.  

Personal loan  

A personal loan from a bank can help you pay off your car finance agreement.  

If the interest rate and other lending terms are correct, you won't need another hire purchase agreement and can repay your car at a fixed rate over the time your bank offers.  


If you have significant savings, you can use them to repay your car rather than refinance.  

It's critical to note that spending all of your savings isn't advised. Having an emergency fund helps you with last-minute expenses and unexpected debt. If you can, retain some of your savings for future expenses! 

Formal repayment plan for other debts  

If you’re in serious financial difficulty and can’t keep up with repayments, 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. You can work with a professional advisor to find the right option for you. 

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.    
  • Look at your Credit Utilisation Ratio — Your ‘credit utilisation ratio’ is an essential factor that lenders look at when sanctioning borrowing. This is the amount of credit you’re using compared to the amount available. If it’s relatively low, your credit score will be better.  

Step 3: Supporting documentation for your application  

  • Show your lender your ID & loan agreement — 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  

  • Make the final checks — 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 and celebrate — Sign for your car refinances if you’re happy 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.   

Final tips for refinancing a car loan 

Now you know what refinancing is, the pros and cons of refinancing a car, and how to get started, take a look at our final tips for anyone considering refinancing.  

  • Crunch the numbers — Online car payment calculators can help you work with accurate figures. 
  • Shop around — Don’t settle for the first lender you come across. 
  • Get the documents ready early — This will save you time and stress, we promise! 
  • Check your credit score — Knowing your score earlier avoids surprises further down the road. 

Is car refinancing right for you? The bottom line 

Refinancing your car can significantly affect 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.   

But before you start, you must be aware of the drawbacks!  Refinancing isn't right for everyone. So, spend some time researching to help you make an educated choice that benefits your finances. 

How Bumper can help 

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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