You recently purchased a new ride and would like to know when it’s a good time to refinance. There’s no rule set in stone that dictates when you can move forward with a refinance. But it could be sensible to wait until the time is right.
In this guide, you’ll learn more about how refinancing works, if it’s a smart financial move, when it’s best to apply for a new loan, or how often you should refinance your car loan. You will also learn about mistakes to avoid when you refinance your vehicle and how to get started to help you lower your car’s monthly payments.
How Does Auto Refinancing Work?
When you refinance your car, you apply for a new loan to replace the one you currently have. Upon approval, the lender pays off your existing loan, and you resume payments but on the new loan. As a result, you will end up with a new interest rate and monthly payment schedule. Some borrowers use this opportunity to get a lower rate and reduce monthly payments, while others opt for higher monthly payments to get out of debt sooner.
Before deciding on the interest rate and loan terms, financial institutions will look at your credit report, debt-to-income ratio, and other factors to assess risk. Borrowers with higher credit scores and lower debt-to-income ratios tend to qualify for the best loans. So, having good numbers in those areas can help you potentially save thousands of dollars on your auto loan.
Should You Refinance Your Car?
Refinancing your auto loan is an important decision, but does it make sense for you? Of course, it depends on your financial situation and reasons for wanting to refinance. Here are some reasons to consider getting a new loan:
- Your credit score has improved since you applied for your current loan. A higher credit score can help you secure lower interest rates on a refinance.
- The average interest rates on car loans have dropped over time, and you believe you could qualify for a better rate. Most auto owners get fixed-rate loans that don’t benefit from declining interest rates, but this also safeguards them from rising interest rates. A refinance can help you capitalize on lower interest rates.
- You want to reset your loan term to get a lower monthly payment and free up funds for other financial goals. This strategy frees up more space in your monthly budget.
- You’re experiencing financial hardship and desperately need a lower payment to avoid serious credit consequences and repossession. Payment history makes up 35% of your credit score, and a lower monthly payment can keep you in good standing. A refinance can provide critical breathing room if funds are tight.
- You accepted a rebate from the dealership in exchange for a higher interest rate. The rebate gives you an immediate discount, and you can quickly look for another lender to refinance the loan. This strategy can get you out of the higher interest rate, but you should check for prepayment penalties.
- You want to remove a co-borrower from the current loan. Some people no longer want to be co-signers once the car owner has a good enough credit score to qualify on their own. The co-borrower will also have a lower debt-to-income ratio if they get removed from the loan.
- You want to get a lower interest rate and continue making the same payment to pay the loan off sooner. Shortening a loan usually results in a higher interest rate, but if you took out your first loan with bad credit and rates have dropped since then, you might get a lower interest rate and the ability to pay off your loan faster.
It is important to weigh your options, so using an online service to refinance your vehicle may be a good place to start getting free quotes from a number of lenders. In addition, you can get several loan offers from a streamlined platform instead of reaching out to individual lenders one at a time.
Reasons Not Refinance Your Car
Unfortunately, there are also potential drawbacks to vehicle refinancing. Keep these disadvantages in mind before refinancing your auto loan:
- You could pay more interest over the life of the new loan. Lenders charge interest on every monthly payment. Interest shows up in each of those monthly payments.
- The new lender may charge steep loan origination fees. High fees can minimize the ROI of getting an auto loan refinance.
- Your current lender could penalize you for paying off the loan early. The prepayment penalty can cancel out the money you would save from using a new loan. Borrowers can still profit from car refinances, but it’s important to consider how expenses like prepayment penalties will impact your bottom line.
How Soon Can You Refinance Your Car?
You can refinance your car once your lender obtains the title from the previous owner or manufacturer. But it may not be a good idea to refinance right away. Your credit score could still be recovering from the hit it took when you opened the loan.
If possible, wait at least six to twelve months before refinancing to give yourself the best chance at getting a new auto loan with favorable terms. Waiting at least a year is even better as your credit score can recover from the hard credit check and grow with on-time loan payments.
Refinancing may also not be worth it if you’ve had your car for some time. For starters, your vehicle may not qualify if it’s more than 10 years old or has over 100,000 miles on it. Even if you can get a refinance, you’re looking at a higher interest rate. If your car is that old, there’s a chance you’ve already paid the bulk of the interest and are nearing the end of the loan term. If the remaining loan amount is small, a refinance may not make sense.
Does It Hurt Your Credit To Refinance Your Car?
When you apply for an auto loan, a hard credit inquiry is generated and could drop your credit score by a few points. Furthermore, opening a new loan may lower your score again as your average age of accounts will decrease (if you’ve had your current auto loan for some time). The good news is your score will start to improve sooner rather than later, assuming you manage your outstanding debt obligations responsibly. So make sure you understand how your credit will be affected before entering the refinancing process.
Mistakes to Avoid When Refinancing Your Car
Getting a refinance can help you save money, but there are some common mistakes people make when obtaining a new loan. You should avoid these mistakes when refinancing your vehicle:
- Getting a new auto loan when your current lender charges prepayment penalties if you pay off your loan early.
- Accepting an extended loan term drastically reduces your car payment but costs you a fortune in interest over the loan term and puts you upside down in the loan.
- Securing a loan with more favorable terms is too close to the end of your repayment period on your current loan.
