When does refinancing a car loan make sense?

When does refinancing a car loan make sense? When does refinancing a car loan make sense? Image:

In a Nutshell

If you've taken out an auto loan to pay for your car, refinancing could help you save money in the long run. Give it extra-serious thought if your financial situation has improved or interest rates have dropped since you took out your last loan.

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Have you taken out an auto loan to pay for your car? You may be able to refinance that loan to lessen your financial burden.

Refinancing a car loan involves taking on a new loan to pay off the balance of your existing car loan. Most of these loans are secured by a car and paid off in fixed monthly payments over a predetermined period of time — usually a few years.

People generally refinance their auto loans to save money, as refinancing could score you a lower interest rate. As a result, it could decrease your monthly payments and free up cash for other financial obligations.

Even if you can’t find a more favorable rate, you may be able to find another loan with a longer repayment period, which might also reduce your monthly cost (although it might increase your total interest cost over the life of the loan).

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If you’re still unsure whether refinancing a car loan is right for you, read on to learn about when it typically makes the most sense.


4 times refinancing a car loan could make sense

A decision as big as refinancing will depend on a number of individual factors. With that said, you may want to give it some extra-serious thought in the following instances:

Interest rates have dropped since you took out your original auto loan.

Interest rates change regularly, so there’s a possibility that rates have fallen since you took out your original auto loan. Even a drop of 2 or 3 percentage points may result in significant savings over the life of your loan.

Your financial situation has improved.

Lenders can use a number of factors to decide your auto loan rate, including your credit score and debt-to-income (DTI) ratio, which is calculated by dividing your monthly income by your monthly debt payments.

As such, improving your credit health and decreasing your DTI ratio can lead to more favorable terms on your refinanced loan.

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You didn’t get the best offer the first time around.

Even if interest rates haven’t dropped or your financial situation hasn’t improved significantly, it may be worth shopping around for better loan terms anyway. For example, you may have received a loan with an interest rate of 7 percent when other lenders were offering lower rates.

This may be especially prudent if you got your original loan from a car dealer, as dealers sometimes offer higher interest rates to make extra money.

You’re having trouble keeping up with bills each month.

Even if you’re not able to secure a lower interest rate, it may still be worth trying to find a loan with a longer repayment period in order to reduce your monthly payments.

If you can’t find a suitable loan, you may also be able to renegotiate the repayment period on your current loan. However, keep in mind that more time spent paying back your loan is also more time spent paying interest. In general, you’ll pay more interest overall if you have a loan with a longer term.

Is auto loan refinancing worth the effort? In many cases, yes

When should you hold off on refinancing?

Refinancing can save you money, but it’s not always the best option. You may want to hold off on refinancing if any of the following applies to you:

You’ve already paid off most of your original loan.

Interest is often front-loaded, meaning you pay more of it off in the beginning. The longer you wait to refinance, the less you may be able to save on interest.

Your car is old or has a significant amount of miles on it.

Cars depreciate quickly, so you’ll likely only be able to refinance within the first few years of owning your car. Some lenders, for example, will not refinance cars that are older than seven years or have more than 75,000 miles on them.

The fees outweigh the benefits.

It’s important to look out for any fees associated with refinancing. For example, there may be prepayment penalties for paying off your original loan earlier than planned with your refinance loan. You may have to pay some additional interest in addition to the principal.

Even worse, some loans, such as loans with precomputed interest, make you pay all of the interest in addition to the principal.

You’re also likely to incur refinance fees. These can include lien holder and state re-registration fees, which don’t usually cost more than $85 combined. While they’re not enormously expensive, it might be a good idea to see if you can afford these fees before you refinance.

You’re looking to apply for more credit in the near future.

Refinancing could negatively impact your credit. If you’re considering applying for a mortgage or that really exclusive credit card you’ve had your eye on, you may want to hold off on refinancing to keep your score as high as possible and maintain your chances of being approved.


Bottom line

Refinancing can save you money, but you should only consider it when the circumstances are right.

If interest rates are lower or your financial situation has improved, it may be worth shopping around for a loan with better terms. But make sure you don’t wait too long, or the benefits of an auto refinance loan may not be worth it.


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