Pros and Cons of Refinancing a Car

Considering a car loan refinance? If you’re reading this, you’re already doing your research – and that’s a smart start.

In certain circumstances, refinancing a car loan could lower your monthly payments and help keep some extra money in your pocket. But refinancing comes with tradeoffs as well. That’s why it’s important to weigh the pros and cons of auto refinancing.

From what car loan refinancing is to how it may impact your finances, we’ve gathered some information to help you make an informed decision.

How does refinancing a car work?

Refinancing an auto loan simply means that you pay off your current car loan with a new one. Depending on your credit score and payment history, auto refinancing could lower your interest rate or monthly payment or change the duration of your loan. If you're approved for an auto refinance loan, the new lender will pay off your existing loan, and you'll start making payments on the new loan, which ideally has terms that better suit your financial situation.

Pros and cons of refinancing your car

Will refinancing your car loan bring you closer to your financial goals? Here are some pros and cons to consider as you weigh your options.

Pros of refinancing a car

You could get a better interest rate

Interest rates can make a difference if your current loan has a high interest rate, refinancing to a lower one could help—but there are other things to think about too. A lower rate doesn’t always mean lower payments or less interest in the long run. If the new loan has a longer term, you might pay less each month but more in total interest over time. Also, check the APR (Annual Percentage Rate), which includes fees and other costs. Looking at the full picture can help you decide if refinancing is the right choice.

You could lower your monthly payment

Refinancing may help reduce your monthly car payment in a couple of ways:

• First, if you secure a lower interest rate, the monthly payments could be lower.
• Second, you may be able to extend the term of your loan. For example, if you extend the term to 60 months from 48 months, your monthly payment will likely be lower.

However, be aware that extending the term of your loan may increase the interest and total amount you pay back over time. You can use a personal loan calculator to compare monthly payment amounts over shorter and longer terms.

You could borrow extra money

Research what your car’s worth. Over time, as you make payments on your car and reduce the total amount you owe, you may start to build equity. In rare cases, some cars—especially rare or popular classic makes and models—can increase in value. When this happens, some lenders may offer you a cash-out refinance.¹ This type of loan helps you refinance your auto loan and borrow extra money based on how much equity you have in the vehicle.

Using a calculation called a loan-to-value ratio (LTV), lenders conduct a risk assessment to see how much of a loan you qualify for. The LTV is the amount of your loan divided by the car’s actual cash value.² Depending on how much your car is worth, you may qualify for a higher loan amount. You could then use the extra funds to pay off other expenses like credit card bills or simply have extra money in your pocket.

Cons of refinancing a car

You might pay refinancing fees

Auto refinancing can include a variety of costs, including application, origination and title transfer fees.

However, not all lenders charge the same fees, and some may not charge any at all. When comparing refinancing options, read the fine print and factor in all associated fees. Paying too much to refinance your car loan could cost more in the end than staying put on your current loan.

You could pay more overall interest over the life of the loan

Getting a lower interest rate may be able to save you money, but it’s not a sure thing. If you extend the term of the loan, you might pay more interest over the life of the loan.

For example: If you currently have a $10,000 loan with a 20% interest rate over a 36-month term, you’ll pay $3,378.89 in total interest. If you refinance that same $10,000 at a 15% interest rate for 60 months, you’ll pay $4,273.96. That’s almost $900 more.

However, paying extra interest over time may be worth the convenience of lower monthly payments. It all depends on what makes sense for your financial situation.

Should you refinance your car?

It depends on your situation. For example, if your credit score decreased since you took out your original auto loan or you missed a payment, you may not qualify for a lower interest rate. Here are some of the best times to consider refinancing your car loan to help you make this decision:

• Interest rates drop: If market interest rates have significantly decreased since you first took out your car loan, it could result in a more favorable rate for you.

• Your credit score improved: If your credit score has increased since you got your original loan, you might qualify for a lower interest rate.

• You've made on-time payments: If you've made all your payments on time, you may have a better chance of getting approved.

• You want to lower your monthly payments: If you're struggling with your current monthly payments, refinancing to a longer-term loan may lower them.

• You find a better loan: When you find a loan with better terms and conditions, such as lower fees or a more flexible payment schedule.

• Life changes: If you have had a major life change, like a new job or an increase in income, refinancing might be beneficial.

Alternatives to refinancing your car loan

Refinancing a car loan can be a common strategy to lower monthly payments or reduce interest rates. However, it's not the only option. Here are four alternatives to consider if you're looking to manage your car loan more effectively:

• Loan modification: Contact your current lender to discuss modifying the terms of your loan. This can include extending the loan term to reduce monthly payments or negotiating a lower interest rate based on your improved credit score or financial situation.

• Making extra payments: If you have some extra cash, consider making additional payments towards your principal balance. This could reduce the overall interest you pay over the life of the loan and help you pay off the loan faster.

• Trade in your vehicle: If your current car loan is burdensome, consider trading in your vehicle for a more affordable one. This may lower your monthly payments and reduce your financial strain.

• Sell your car: Selling your vehicle and using the proceeds to pay off the loan might be a drastic but effective solution. This option is particularly useful if your car's value is higher than the remaining loan balance. It could allow you to clear the debt and possibly have some funds left over.

Each of these alternatives has its own set of advantages and potential drawbacks, so carefully consider which option fits your financial goals best.

Ready to make a decision?

Remember that you have options. While the prospect of possibly saving money can be exciting, a refinance is nothing to rush into. Taking time to do research and consider both sides of the coin is the best way to make a confident decision.

Source:

1 https://www.creditkarma.com/auto/i/cash-out-refinancing-car-loan
2 https://www.consumerfinance.gov/ask-cfpb/what-is-a-loan-to-value-ratio-in-an-auto-loan-en-769/

This article was updated from its original posting in 2021. Kim Gallagher and Jessica Leshnoff contributed to this post.