When Does Refinancing a Car Loan Make Sense?

Refinancing an auto loan may offer many benefits, including a lower interest rate and freeing up money for other expenses. But is it the right choice for you? And how do you know when you should refinance your car? It all comes down to a few important factors including your credit score, current interest rate and payment, and financial goals.

Should I refinance my car?

Common reasons for refinancing a car loan include:

• Saving money with a lower rate — Interest rates can make a difference in both the size of your monthly payment and the total interest you pay over the life of the loan. Lowering your payment by a percentage point or two can make a difference and save you money in the long run. Has your credit score gone up significantly from when you first bought the car? Is your current rate much higher than rates you see available today? If you’re currently in a position to qualify for better loan terms, a refinance would be worth considering.

• Getting your payments back on track — Financial setbacks and other hardships can happen to anyone. If your existing car payment is stretching your budget beyond your means, refinancing could help lower your monthly payment by extending 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.

• Shortening the length of your loan — If you refinance a loan and are able to shorten the length of time you take to repay it, you will save money by paying less interest over the life of the loan. So if you want (and have the means) to pay off your loan early, but your current lender charges a fee for doing so, refinancing could be the opportunity to do just that.

While these are the most common reasons many car owners consider refinancing their auto loan, there are more questions to ask yourself before deciding whether refinancing is the right choice for you. It's especially important to consider the origination fees charged for refinancing. These fees may increase the overall cost of a loan. They may also reduce the amount of money that you receive or that is available to pay off your existing loan. Use the annual percentage rate or APR, which includes both interest and upfront charges like origination fees, to compare the cost of competing refinancing offers.

Does refinancing a car boost your credit?

A refinance may trigger a hard inquiry into your credit history, much like when you apply for a credit card. That means it will show up on your credit report and may influence your credit score. But if the refinance leads to a lower monthly payment and you build a steady history of on-time payments, that is likely to have a positive impact over time on your creditworthiness.

When should I refinance my car?

As with many decisions, timing is everything. Knowing when you should refinance your car can help you determine the right time to make such an important financial decision. Consider refinancing when:

• Your credit has improved — Did you have bad credit when you purchased your vehicle? If your credit is better now, it’s worth checking with lenders to see if you might qualify for a lower interest rate.

• Your circumstances have changed — In addition to your credit score, factors such as an increase in income and work history are equally strong to ensure a well-balanced application.

• Loan rates are down nationwide — When loan rates take a dip, it may be a good idea to check out what rates are available. With the right timing, you may be able to lock in a much lower rate on a new loan.

• You’re looking for a better lender for your needs — All lenders are not alike. If you’ve been having a tough time with your current loan company, you may want to do a little research to find a lender with a proven history of quality financial services and solid track record of customer care.

Conversely, bad timing can yield less-than-ideal results if you choose to refinance your auto loan. You may want to think twice about refinancing if:

• You owe more on your car than it’s worth — If you’re upside down on your loan, refinancing may make matters worse, since it adds to the overall cost of the car. Plus, lenders are less likely to finance a car for an amount more than the car is worth.

• You recently opened another loan or credit card account — Applying for multiple forms of financing within a short period of time can negatively impact your credit rating and could result in higher interest rates and undesirable loan terms.

• If your current loan has a prepayment penalty — A prepayment penalty is a fee that some lenders charge borrowers who pay off all or part of their loans ahead of schedule.¹ If your current car loan has a prepayment penalty, it’s important to weigh whether the cost of paying your loan off early is worth the savings you may get from refinancing.

Is refinancing the right choice for you?

In most cases, the goal of refinancing your loan is to get a lower interest rate and save money over the life of the loan — or to make your monthly payments more manageable. While everyone’s situation is different, take time to consider the pros and cons of refinancing, review your goals and make sure that refinancing can help you achieve them.

1. https://www.forbes.com/advisor/mortgages/prepayment-penalty-what-it-is-and-how-to-avoid-one/