Is Refinancing an Auto Loan a Good Idea?

Refinancing a car loan simply means getting a new loan to pay off an existing auto loan, with the car as collateral. This is an appealing option if you find yourself low on cash or you learn about a better interest rate deal.

What could possibly happen if you refinance a car loan?

  • Lower monthly car payments. If you refinance your auto loan, it’s possible that your monthly installment amount will decrease due to lower interest rate or a longer term, or both.
  • Reduced interest rate. If you qualify for a lower interest rate in the new loan, it may mean that you will be paying a lower interest rate for your debt in total, provided that the loan is not extended to a longer term.
  • Extended loan term. In this scenario, your monthly payments will be smaller and you will have more time to pay for your loan. However, this may result in paying more for the car in total, considering the interest.
  • Shorter loan term.  On the other hand, your loan term can also be shorter, making your monthly payments higher, but the total payment lower due to the lower interest rate.

When is it a good idea to refinance a car loan?

Before deciding to refinance your auto loan, it is best to peruse your current situation and see if it will be in your best interest to push through with it. Here are scenarios in which car loan refinancing makes sense.

  • You see a significant drop in interest rate from the first time you took out the original auto loan. A two- or Three-percent drop in interest can spell huge savings in the totality of your loan.
  • You need to save money immediately due to an emergency expense or a sudden decrease in income. If you need to free up some cash the soonest possible time, it may be a good idea to refinance your car loan as it can lower your monthly financial obligations for the car.
  • You can also consider taking this step if your credit score has improved since the time you took the original auto loan. Better credit score means lower interest rate, which means big savings down the road.
  • Your debt-to-income ratio has improved. As with credit score, lenders look into your current financial situation in determining the appropriate interest rate.
  • Even if your financial situation did not improve or your credit score is not any better, it is still a good idea to shop for better interest rate deals than what you got the first time. If you took your original loan from a car dealer, chances are they offered you higher interest rates.

When is it not a good idea to refinance a car loan?

  • The longer you wait to refinance, the lesser you save on interest. If you’ve paid off most of your original car loan, it would be best to just finish paying it off, and not refinance anymore.
  • Unlike other types of properties, cars depreciate quickly. If your car has already incurred a significant amount of miles, it’s probably not a good idea to refinance.
  • If transaction fees, among other fees that come with refinancing, would just offset the savings, better not push through with refinancing your auto loan. These expenses may not be that high, but it is best to evaluate if you can afford these fees before refinancing.