You can refinance your car loan by taking out a new loan and using it to pay off your old loan. You will then pay off the new loan. This process can lower your interest costs or your monthly payment. It could get you out of a relationship with a lender that you don’t like or allow you to remove a cosigner from your loan.
Refinancing can be a useful tool depending on your situation. Knowing when to refinance and what to look for in a loan can help you to determine whether refinancing will help you achieve your financial objectives.
What Can a Refinancing Loan Accomplish?
The average American car loan has a 5-year term, and terms up to 8 years are becoming more common. A lot can happen in that time and changing conditions may make it possible to get a better deal on your car loan. There are several potential reasons to refinance a car loan:
- You can get a lower interest rate. If your credit has improved since you got your car loan, if car loan rates have dropped since you got your loan or if you didn’t shop around enough before borrowing, you may be able to get a substantially lower rate on a new loan.
- You can get a lower monthly payment. If your new loan has a longer-term than your current car loan your monthly payments may become lower. You should think carefully before doing this, however, as a longer-term usually means higher total interest costs, but if you’re having a hard time making your payments and you’re at risk of default it could be worth it.
- You can get a better lender. If your existing lender has poor customer service or you’re just not satisfied with the business relationship, you may want to seek a new loan.
- You can release your cosigner. If you have a cosigner but no longer need one, refinancing is a way to remove your cosigner from the loan.
The first step in the refinancing process is to determine the specific goals you wish to accomplish by refinancing. Knowing exactly what you want will help you evaluate potential loans and determine whether they meet your goals.
Is it Time to Refinance?
Will refinancing help you? Here are some signs that would suggest that it could:
- Your credit has improved since you got your loan. Better credit means you’re likely to be offered a better rate on your new loan.
- Rates on car loans have improved since you got your loan. Interest rates fluctuate regularly, and they may have gone down since you got your loan. If they have, you may get a better rate. If interest rates have gone down and your credit has improved, your new rate could be substantially better.
- You’re having a hard time making your monthly payment. If your income has dropped or other expenses have emerged, you may be having a hard time meeting your monthly payment. Refinancing with a longer loan term can reduce your monthly payment. It may also increase your total interest cost, but missing payments could damage your credit, and that could cost you more.
- You didn’t shop around enough for your first loan, and you know you can get better terms. You should always check multiple sources before taking out a substantial loan, but many people don’t. Many car buyers just take whatever financing package the dealer offers. If you made that mistake, refinancing could help you correct it.
- You don’t like your lender. If your lender has poor customer service or the business relationship hasn’t been good, refinancing can get you a new lender.
- Your cosigner wants out. If your cosigner needs to reduce their debt-to-income ratio, which can be a factor in applying for a mortgage or other large loans, they may want to be released from their obligations. Refinancing can accomplish that.
If any of these descriptions apply to you, it may be a good time to refinance. If more than one applies to you, refinancing could be just the step you need to get a better deal.
What’s the Wrong Time to Refinance?
Refinancing is not magic, and it’s not the right tool for every situation. There are also signs that refinancing won’t help you.
- Your credit is the same or worse than it was when you got your loan. If your credit has deteriorated since you got your original loan you probably won’t get a better rate. You may end up paying a higher rate.
- Interest rates have stayed the same or risen since you got your loan. If market interest rates have risen since you got your loan it may be difficult to get a better deal, unless your credit is much better than it was.
- Your loan has a prepayment penalty. Many car loans carry prepayment penalties that add a fee if you pay the loan off early. This fee is designed to protect the lender’s profit margin on the loan. A prepayment fee has to be weighed against your potential gains and can make it difficult to refinance profitably.
- You owe more than the car is worth. Cars depreciate fast, and if you didn’t make a large down payment there is likely to be a period when the balance of your loan is greater than the worth of your car. Most lenders won’t lend more than a car is worth, so you may have to add cash to pay off the loan and close the deal. It’s usually not worth it.
- Your car is still very new. If your car is less than a year old it will usually be worth less than the balance of your loan, unless you made a large down payment. Your refinancing loan is on a used car, and it’s hard to get a used car loan on terms that can compete with the terms on new car loans.
- Your car is old. Interest rates are usually lowest on new vehicles and used car rates are usually higher than new car rates. Some lenders have an age cutoff and won’t refinance cars over that age, and even if they will it may be hard to get a better deal than the one you’ve got.
Refinancing works best when you get a substantially better deal on your new loan. If the deal on your new loan is not significantly better than the deal you had on the old one refinancing may not be worth the time and effort it takes.
Always Compare the Numbers
Shopping for a refinancing loan is just like shopping for any other loan: you’ll identify several prospective lenders, apply for loans, and compare the proposals you get to identify the best one. Try to check a mix of lenders, including online lenders, local branches of national banks, and local banks and credit unions.
Be sure to keep your shopping in a 2-week period. Each application will generate a hard inquiry on your credit report, and those inquiries can affect your credit. If inquiries for similar loans are grouped together the credit monitoring companies will recognize that you are shopping and register only a single hard inquiry on your credit report.
You will not just compare the proposals you get to each other. You also need to compare them to your existing loan. Focus on the goals you want to achieve through refinancing and determine whether your new loan will achieve those goals.
Remember to assess the full cost of the new loan. You may pay an origination fee or other fees for your new loan. When you calculate your interest savings, be sure to offset the other costs of the loan. If the fees for the new loan are larger than or the same as your savings it may not be worth proceeding.
Is Refinancing Right for You?
Refinancing can be a valuable tool and may help you achieve your financial objectives. However, refinancing might not always be the right thing to do.
To use refinancing effectively you’ll have to determine the goals you want to achieve by refinancing, check your credit to determine what terms you’re likely to be offered, and see what your options are for new loans.
If it’s clear that a new loan will achieve your objectives, you can refinance with confidence that you’re making the right move. If it will not achieve those objectives, you may have to consider other options.