Owning a car instead of making lease payments can significantly reduce your cost of living in the long term. Eventually, the auto loan payments will go away, and you will own your car free and clear. Many car owners will happily make the short-term sacrifice of higher monthly payments in exchange for no payments in the future. Some borrowers refinance their auto loans along the way to capitalize on several benefits. We will discuss some advantages of a car loan refinance and some disadvantages to consider.
How Does Car Refinancing Work?
When you get a refinance, you are replacing an old loan with a new loan. You still owe the remaining principal on your auto loan, but the terms have changed. These changes can impact the loan’s interest rate, the life of the loan, and other factors. It’s a way to adjust course when you believe it’s time to modify your plan.
When Should You Refinance Your Car?
Vehicle refinancing is a great resource, but it doesn’t always help. Not every borrower should rush to refinance a motorcycle, car, or another vehicle. Instead, you should consider if you meet any of the following parameters before reaching out to your lender about a refinance.
Your Credit Has Improved
The lender will look at your credit score when you apply for any loan. This number gives banks a quick snapshot of your ability to manage debt. Financial institutions will review your credit report and other financial details before making an offer. Consumers with higher credit scores have lower risks to banks since they get high credit scores by effectively managing their financial obligations over time.
Some borrowers get their first loan when their credit scores aren’t as good. The minimum qualifying credit score can lead to higher interest rates. Raising your score and applying for a refinance can help you score lower rates and reduce your monthly payments.
Consumers have several ways to improve their credit scores, but most of it comes down to making on-time payments. Your payment history makes up 35% of your credit score and has a direct impact on credit utilization, which makes up 30% of your score.
Interest Rates Have Decreased
Improving your credit will help you get a lower interest rate, but sometimes, the bank will lower rates across their loans. The Federal Reserve dictates interest rates. When they lower interest rates, loans become more affordable. You can refinance a loan with a higher rate to take advantage of the Fed’s lower interest rate.
Lately, the Federal Reserve has been raising interest rates. Some people are getting loans now because they fear the Fed will continue raising rates in the foreseeable future. There’s speculation that the Federal Reserve will soon reverse course and lower rates, but consumers may want to wait for that moment to materialize.
Compare your current loan’s interest rate with the interest rate of the refinanced loan. If the interest rate is lower on the refinanced loan, it may make sense to refinance your vehicle.
Your Loan Is Relatively New
You can refinance a loan to capitalize on lower payments, but you will owe fees. The refinancing fees are worth the investment if you have a new loan. However, a refinance may not make sense if you only have a few months left on your current loan. You may get a lower interest rate, but refinancing costs can put you at a net loss for a small loan. A refinance makes more sense if you have more time left on your loan.
You Have an Emergency
Not everyone refinances a loan to save money. Some people need to do a cash-out refinance or extend their loan to reduce the monthly payments. These strategies prolong your auto loan payments but offer financial protection in case of an emergency.
When Should You Not Refinance
Refinancing a car offers several advantages. However, there are a few instances where it is not a good idea to refinance. These are some of the signs you may want to consider as an alternative way to raise money to free up space in your budget.
Interest Rates Have Gone Up
A higher interest rate will increase how much you pay over the loan’s lifetime. Some people locked in low fixed rates with their initial loans and shouldn’t replace them. There are other ways to borrow money, such as through a personal loan if you need the extra cash and do not want your interest rate to change.
You are Close to Paying Off the Debt
An auto loan refinance will prolong your path to a debt-free car. You will also incur additional fees, making it more difficult to get out of debt. If you are 1-2 years away from having a debt-free car, trying to make it work rather than refinancing may be better.
Getting out of auto debt will save up a lot of space in your budget. Short-term pain for long-term gain is better than instant gratification. You can work an extra side hustle for a short time to make ends meet until you free up more space in your budget by fully paying off your car.
Pros of Refinancing a Car
Are you considering if a car loan refinance is right for you? Refinancing your auto loan can provide you with numerous advantages.
Reduce Interest Rates
If you raised your credit score since your first loan, you could probably get a lower interest rate with a refinance. Lower interest rates make your loan more affordable.
Lowers Your Monthly Payments
A lower interest rate translates into a lower monthly payment, but that’s not the only way to reduce your costs. You can also extend the duration of your loan to spread your monthly payments over additional time.
Pay Off Your Loan Earlier
Some people have the financial flexibility to continue making loan payments, but they want to get out of debt sooner. You can request a loan with a shorter duration and become debt-free sooner. This strategy will increase your monthly payments, but some borrowers want to get it over with and get rid of their loans. You can also use this approach to get out of lease payments.
Tap Into Your Car’s Equity
You can use a cash-out refinance to obtain additional funds. While you will prolong your loan’s repayment, some people use this strategy to cover emergency expenses or raise enough money for a vacation or down payment. You can use the money in any way you want. Not everyone uses a cash-out refinance, but it’s a useful option.
Improve Your Cash Flow
Reducing monthly payments will improve your cash flow. For example, a lower interest rate or extended loan can save you over $100 per month. Better cash flow gives you more money at the moment that you can deploy into everyday expenses, investments, and other resources.
Consolidate Your Debt
Having several small debts can feel stressful, especially if any of them is credit card debt. You can consolidate your debt with a cash-out refinance. Some borrowers use the proceeds to repay credit card debt and other high-interest debt. Then, instead of opening up several tabs to keep up with financial obligations, you can have all of your debt tied to your car. Debt consolidation is a simplified approach to paying off financial obligations.
Cons of Refinancing a Car
While a refinance offers numerous advantages, this financial resource comes with some setbacks. Keep these disadvantages in mind before getting a loan to refinance. These disadvantages are not significant enough for some borrowers but can be notable for others.
Paying Refinancing Fees
Banks won’t let you refinance a loan for free. You will have to pay several fees that will be added to the backend of your loan. While you can absorb these costs for a new loan, a loan with a few months left won’t absorb these extra fees as well. If you don’t have much time left on your loan, leaving it in its current state makes more sense.
You May Pay More Interest Overall
Some borrowers extend the duration of their loans to reduce their monthly payments. This strategy gives you more cash flow at the moment, but it will also increase your total interest payments. In addition, if you tack the refinancing fees onto the backend of your loan, you will owe interest on those costs. A lower interest rate can mitigate this risk, but lower interest rates aren’t always enough.
You Could be Upside Down on Your Loan
Cars depreciate quickly, but your principle remains the same. A refinance can put you upside down on your loan, meaning that the loan’s principal exceeds the car’s value. Some borrowers can accept this short-term sacrifice as they continue making loan payments. However, an upside-down loan can complicate efforts to sell your vehicle. If you sell your car for $25,0000 and owe $28,000 on the loan, you have to come up with the remaining $3,000 to complete the sale.
Watch Out for Longer Terms
Longer loan terms give you more cash at the moment, but they can become problematic. You will have to pay more interest over the loan’s lifetime, and some borrowers get too comfortable with extending their loans. You can end up paying far more for the loan by continuously extending it instead of paying on the current schedule.
How to Refinance a Car Loan
People who want to refinance their car loans can follow these steps to get a loan with competitive terms.
Check Your Credit Score
Creditors will look at this three-digit number when assessing your application, and many of them have minimum requirements. Knowing your credit score will help you determine which loans you qualify for. If your score is too low, you can use this opportunity to build your score and add some extra points before submitting an application.
Compare Auto Loans
Don’t rush to accept the first auto loan you find. Comparing several auto loans can help you find one with a competitive interest rate, lower fees, and reasonable terms. Check in with banks, credit unions, online lenders, and lending marketplaces during the shopping process.
Apply for the New Loan
You can apply for a few loans within a 14-45 day window and have it treated as one hard credit check. Applying for several loans at the same time will give you more offers to choose from.
Repay the Old Loan and Start the New One
If you get approved for a new loan, the capital from that financial product will be put toward the remaining balance on your current auto loan. At this point, you have replaced your auto loan and have a new rate and terms.
Is Car Refinancing Right for You?
A car refinance has several applications. Some people use a refinance to reduce their monthly expenses, while others use it to tap into equity. A car refinance can help with many financial objectives, but you should consider the disadvantages before starting the process.
Get Loan Offers to Refinance Your Car
If you are considering a car refinance but find it exhausting to reach out to lenders, you’re not alone. You can get a refinance from banks, credit unions, online lenders, and other institutions.
Lending marketplaces are also great options, as they have partnerships with many financial institutions, banks, and online lenders. Your application can go out to numerous lenders if you submit it through a marketplace. Make sure you fill out several applications so you can compare rates and terms. You can save a good amount of money by shopping around instead of going with the first lender you find.
Frequently Asked Questions (FAQs)
You should compare other auto loans with the loan that you currently have. It is also a good idea to assess your finances and your ability to pay off your current loan before deciding if a refinance is right for you.
Putting money down during a refinance can increase your chances of getting approved and result in better loan terms. You can reduce your monthly payments if you put more money down and get out of debt sooner.
