When it comes to financial planning, rethinking your loans is always on the agenda. Deciding to refinance a car can be a good step toward lowering your financial burden.
Over 44% of Americans rely on auto loans to finance a vehicle purchase. Knowing when (and if) to refinance can improve your financial situation substantially.
Is it always a good idea to refinance an auto loan? Your decision should depend on a number of factors.
Advantages of Refinancing a Car Loan
The key goal of refinancing is to bring you financial benefits. The main advantage of switching to another loan is reducing current payments.
1. Reducing the Interest Rate
If you’d like to decrease your monthly payments, it’s possible to find a loan opportunity with a lower interest rate. Two ways to do it are:
- Review your credit history — if it improved by at least 50 points since you’ve taken out a loan, lenders may be willing to refinance with a lower interest rate.
- Shop around — other lenders may be offering lower rates than your current lender.
Example: You took out a $10,000 loan at a 10% interest rate for 60 months. Your original monthly payment was $212. You paid off about $2,000 and decided to refinance with an interest rate of 6% and a loan duration of 48 months. Your new monthly payment will be $195.
Over the course of the loan, you’ll save $816.
2. Tapping into Equity
If you’ve already built some equity while paying off your auto loan, you can tap into it during refinancing.
Cash-out auto loan refinancing allows you to replace the current loan with a new one and borrow an extra amount against the equity you’ve built.
You may even get a lower interest rate on the new loan while enjoying the extra cash for your current needs.
Example: Your vehicle is currently worth $10,000. You still need to pay off $7,000. You can refinance your vehicle for $8,500 (which is still less than its worth) and get $1,500 in cash.
3. Adjusting the Loan Term
Refinancing can help you either shorten or extend the duration of your auto loan:
- Reduce the term — by taking advantage of a lower interest rate, you can reduce the loan duration while keeping monthly payments at the same level.
- Extend the term — if you are struggling with high monthly payments, extending the loan term can help you reduce the current monthly amount.
Example: Your current monthly payment is $180 (remaining loan term — 4 years; amount left to pay off — $8,000; interest rate — 5%). If you refinance with the same interest rate but change the loan term to 6 years, your monthly payment will go down to $128.
It’s worth noting that by extending the loan duration, you are paying more interest over the life of the entire loan. In the above example, you’d need to pay about $640 extra in interest.
However, it’s an excellent way to cut monthly payments in case your life situation changes, and you can’t find an option with a lower interest rate.
4. Working with a New Lender
In some cases, refinancing an auto loan can be done for convenience purposes. Some lenders may have poor customer service, making the entire collaboration frustrating. Or you may want to take advantage of a financial institution instead of dealer financing.
When deciding to refinance your vehicle for the purpose of changing a lender, make sure to consider all the applicable costs.
Disadvantages of Refinancing a Car Loan
Refinancing isn’t always a financially sound decision. In some cases, you may not save as much as you’d like to or pay more in the long run.
1. Incurring Extra Costs
Refinancing an auto loan comes with a variety of costs, such as:
- Lender fee
- Title fee
- Penalty (your car loan agreement may require you to pay a fee for early closing)
- Closing fees
In some cases, cash-out refinancing simply isn’t worth the effort due to the high processing costs.
2. Paying Additional Interest
If you refinance for a longer term, you incur additional interest. While you decrease current monthly payments, you pay more money in the long run.
Since cars tend to depreciate quickly, you are likely to owe more on your loan than your vehicle is worth at any given time.
3. Extending the Term
While extending the loan term can lower your monthly payments, it increases the payment timeline. You’ll be paying off your loan much longer while your car continues to depreciate.
You may find yourself paying for an old vehicle that requires substantial investments in repairs.
When It’s a Good Idea to Refinance a Car Loan
You may want to consider refinancing your auto loan if:
- Your credit score has improved — with a higher credit score, you are eligible for a lower interest rate.
- You see a better deal — if another lender is offering a lower interest rate, you may want to consider it.
- You have an emergency — if you need extra cash fast, you may want to use a cash-out refinance option.
- Your life situation changes — if you can’t afford current monthly payments, you may want to refinance to lower them.
You are unlikely to be approved to refinance a car if:
- Your car is older than 7 years
- You owe more than the car is currently worth
Pro tip: The best time to refinance a car is when you are about two years through a five-year loan and can demonstrate an improved credit score.
Is Car Refinancing Right for You?
While a lower interest rate or high equity may seem reasons enough to refinance, the process comes with many nuances. Before you refinance a car loan, you need to weigh all the pros and cons related to short-term and long-term outcomes.
If you’d like to learn more about making car refinancing decisions and other financial planning opportunities, please contact us at any convenient time. At Bogart Wealth, our mission is to help clients achieve financial peace of mind.