Choosing to refinance a loan is a major decision. While there are certainly benefits to refinancing, considering the potential downsides is important as well. If you’re searching for information to help you decide, let’s review the basics before comparing the pros vs. cons.
How does refinancing a car loan work?
Refinancing simply means that you pay off your current car loan with a new loan. Depending on your situation, auto refinancing could lower your interest rate, your monthly payment or change the duration of your loan.
When does refinancing a car loan make sense?
Each borrower is unique. For example, if your credit score has gone down since you took out the original loan or you missed a payment, now may not be a good time to refinance. But, if your credit score has gone up and you made all your payments on time, it might be a great time to refinance.
Both sides of the coin
Now it’s time to look at the potential good and bad of auto refinancing. As you go through the list, try to think how each outcome will impact your situation and goals.
Pros of auto refinancing
You could get a better rate. Interest rates can make a difference in the size of your monthly payment and the total interest you pay over the life of the loan. If your current loan's interest rate is higher than rates you might qualify for, consider a refinance. Lowering your payment by a percentage point or two can make a difference and save you money in the long run.
You can lower your payment. Refinancing can 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 be lower. However, be aware that extending the term of your loan may increase the total amount of money you would have to pay back.
You could borrow extra money. Is your car worth more than you owe on your current loan? If so, you could get approved for a cash-out refinance loan.* This type of loan helps you refinance your auto loan and borrow extra money based on how much equity you have in the vehicle. You can then use the extra funds to pay off other expenses like credit card bills or have extra money in your pocket.
Cons of auto refinancing
You might pay refinancing fees. There are a variety of fees you can run into including transfer, exit and upfront fees. However, not all lenders charge the same fees and some may not charge any at all. When comparing your refinancing options, be sure to include what fees they charge. Paying too much to transfer your car loan could cost more in the end than staying put.
You could pay more interest over the life of the loan. It’s true that getting a lower interest rate can save you money. But 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.
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Do what’s best for you
Comparing the advantages and disadvantages of any product can help you make an informed decision. And since you already have an auto loan for your vehicle, it may not hurt to look around to see if something better is available.
*Important Notice if You Are Considering Debt Consolidation or Refinancing: Before you refinance your other debts with a new loan to reduce your total monthly debt payment, you should consider that the new loan may increase both the total number of monthly payments and the total amount paid over the term of the loan.