Are you torn between refinancing your car loan or keeping your existing loan? Before you make a decision, it is important to weigh the benefits and drawbacks of refinancing. You should also conduct a cost-benefit analysis based on your current situation to determine if you should move forward with vehicle refinancing. It isn’t for everyone, but some people save thousands of dollars by refinancing their loans and reducing the burden of monthly loan payments.
How Car Refinancing Works
Car refinancing involves swapping your current car loan with a new one that contains different terms. Most automobile owners go through the refinancing process to get a significantly lower interest rate, get out of debt sooner, or stretch out their repayment periods to get a lower monthly payment. Some auto loan refinances can achieve multiple objectives at the same time. For example, it’s possible to get a lower interest rate and spread the loan over more years to minimize monthly payments.
When Car Refinancing Is Worth It
Getting a car refinance is an important decision. Of course, it has pros and cons, but these scenarios could make refinancing beneficial for you:
Your Credit Score Has Improved
Didn’t get the rate you wanted the first time? Borrowers with low credit scores have fewer choices and get stuck with higher rates. However, as they pay off their loans, their credit scores increase and open up more opportunities. If your credit score has since improved, you could have luck getting a better deal this time around. Lenders will see you as more trustworthy and be happier to do business with you. But before you apply, scan your credit report for errors or outdated information. You can file disputes promptly to give yourself the best shot at good or excellent credit. Even if you don’t find any errors, obtaining a copy of your credit report provides a more detailed snapshot of your financial health. You can request a free copy of your report every year from each of the major credit bureaus (Experian, Equifax, and TransUnion).
Remember, the best interest rates generally go to the borrowers with the highest credit scores, as they pose the least amount of risk to the lender.
Interest Rates Have Dropped
Interest rates on auto loans tend to fluctuate, which means the average rates could be lower than what they were when you initially financed your vehicle. So, it’s worth scoping out your options to determine if you could qualify for a lower rate and potentially save in interest on your auto loan. Most people use fixed-rate loans to mitigate risk and have to refinance their way to a lower interest rate. You can also get a variable-rate loan that has a fluctuating interest rate, but these loans become less favorable if interest rates rise in the future. Fixed-rate payments always stay the same unless you refinance the loan.
You Need To Lower Your Monthly Payment
People’s financials change each year. Some people get raises while others lose their jobs. If you have financial hardships and have pressing financial goals you want to meet, a refinance can make sense. A lower car payment could alleviate some of the pressure you’re facing. And refinancing your auto loan allows you to do just that, as you’re essentially resetting the clock on your loan term.
Be mindful that you could pay more in interest as you’ll extend the period that the lender can collect from you. Some people can overlook this inconvenience because lower monthly payments alleviate current financial hardships, but it’s important to keep this in mind. Refinancing can help you save money, but you don’t want to excessively rely on this strategy and never end up getting out of debt.
When To Avoid Refinancing Your Car
Even if you can get a lower rate or monthly payment, there are instances where refinancing isn’t sensible. Here are some red flags to watch out for if you are considering a new loan for your car.
If Your Car Is Older
Some lenders won’t refinance vehicles that have accumulated more than 100,000 miles or are up there in age. If your car fits into either category, refinancing probably isn’t a good idea. You might get a lender who is willing to do business with you, but you will get a higher interest rate to compensate for the lender’s risk.
If You Bought Your Car In The Last 6 Months
Considering when and how often you can refinance your car loan. Ideally, you want to wait to refinance until at least six to 12 months have passed. At that point, your credit score will have rebounded from the hit it took when you applied for a loan, and it will appear on your credit report. Most borrowers use refinancing to achieve lower interest rates and monthly payments. Applying for a refinance when your credit score hasn’t fully recovered won’t give you the best financing opportunities. It’s better to wait before requesting another refinance. Keep this 6-month gap in mind if you decide to ask for a refinance and end up getting approved. The 6 months reset themselves during each refinance.
When Refinancing Fees Offset A Lot Of Potential Savings
Refinancing your auto loan could mean incurring prepayment penalties if your current lender charges them for paying off your loan early. You could also be hit with loan origination fees, which could make the costs of refinancing outweigh the benefits. Borrowers should approach a refinance, knowing how much they will save. If you would save $1,000 from a loan refinance, but it would cost $2,000 to get the loan after origination fees and prepayment penalties, it doesn’t make sense to get a loan. Typically, the smaller the remaining loan balance, the less sense it makes to refinance your auto loan.
FAQs About Refinancing a Car Loan
Here are some frequently asked questions regarding vehicle refinancing in case you are wondering if you should refinance your auto loan.
It depends on the loan amount, along with the interest rate and repayment term on your current and new auto loan.
If you refinance for an interest rate that’s 1 percent lower, you could save a sizable sum of money. To illustrate, assume you take out a $30,000, 5-year car loan at a rate of 6.5 percent. Your monthly payment will be $587, and you’ll pay $5,219 in interest over the life of the loan.
If you decide to refinance the remaining balance of $25,202 at the end of the first year into a loan with the same term but a reduced rate of 5.5 percent, your monthly payment will drop to $481. Your interest costs will equal $3,681 for the duration of the loan term.
Be mindful that you made $7,044 in payments during the first year. But only $4,798 went towards the principal, and the remaining $2,246 was allocated to interest. So, with a refinance, the loan would cost you $5,927 in interest.
Ultimately, refinancing would only make sense in this case if you wanted a lower monthly payment.
As evidenced by the above example, refinancing for a rate that’s 3 percent lower could mean a more affordable monthly payment. But because the decrease is more significant, you may save in interest as well.
