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Is there ever a right or wrong time to refinance a car loan?
Whether you opt for a new or used vehicle, buying a car can be an expensive endeavor. It’s no surprise, then, that the vast majority of cars on the road today are financed with the help of an auto loan.
As you pay down that debt over the months and years to follow, however, you may decide that the loan you have simply isn’t working anymore. Or for some people, you might discover that you could save both time and money by refinancing that car loan.
But is refinancing really the right decision for your auto loan? If so, when is the right time to refinance that loan and, more importantly, is there a time when refinancing is actually a bad idea?
Let’s take a look at what it means to refinance an auto loan and when you should (or shouldn’t) consider it.
In simple terms, refinancing is the act of taking out a new loan — either with the same lender or a new lender — in order to replace an existing loan. There are many aspects of a loan that can be changed with a refinance: the interest rate being charged, the monthly payment amount, the repayment term, and even the parties responsible for that debt.
Essentially, refinancing allows you to swap out your car loan for a replacement loan. You’re still in debt, of course, but your loan has been revised in a way that (hopefully) benefits you.
Your new refinance loan will serve to pay off the original loan balance in full. From that point on, your debt will be held with the new lender, so that’s where you will direct any questions or concerns and where you will send your monthly payments.
Each lender will have their own specific guidelines regarding auto refinance loans and eligible borrowers. In general, though, you can refinance an auto loan as early as you’d like, and you can even refinance the same debt more than once.
So, you know that you should probably refinance at some point, especially if it will wind up saving you money. But how do you determine when it’s the right time to refinance an auto loan?
Interest rates overall have dropped. While there are many personal factors involved with any loan you take out, the market as a whole also comes into play. If interest rates were high when you bought your car and have dropped significantly since then, you may be able to save money even if none of your other factors have changed. A lower interest rate can save you a lot of money of the life of your loan.
You can shop around for a refinance loan at banks, credit unions, or online, which will give you an idea of the rates for which you qualify. If they’ve dropped enough, refinancing might be worth the effort.
Your credit score has improved. Your personal credit history and FICO credit score will play a significant role in determining your auto loan terms and interest rate. Over time, though, your score could improve drastically, either because something negative falls off your credit report, you pay down account balances, or your positive payment history lengthens.
If you had bad credit when you first took out your car loan but have since improved it, you may be able to qualify for auto loan refinancing with much better terms and lower rates. Check with your existing lender and competitor lenders to see who is willing to offer the best rates.
You want to adjust your monthly car payment. What would you do with a lower monthly payment? Would you put the difference in savings? Pay down debt? Build an investment portfolio?
Regardless of what you would do with the extra cash, refinancing your auto loan can make it happen. You could lower your monthly car payment with a refinance loan; in some cases, this can be done without a longer loan term, so you’ll still be out of debt at the same time (or sooner if you choose a shorter term to save even more over the life of the loan).
There’s a cosigner on the loan that you want to remove. If you bought your vehicle with a co-borrower — such as an ex-spouse or helpful parent with great credit — and now want to remove them from the loan, refinancing might be your only option.
While some lenders will allow for cosigner release after a specific period of time, refinancing is used most often. As long as you qualify for the refinance loan on your own, based on your credit history and factors such as your income, you can release your co-borrower. Just be aware that in doing so, you could potentially see your interest rate go up.
Of course, as great as refinancing can be, it isn’t without downsides. In fact, there are a few instances when you really shouldn’t refinance your auto loan.
There are penalties involved. Some lenders may charge application or origination fees on a refinance loan. And you’ll want to check whether your current lender will charge any prepayment penalties or early repayment fees if you were to effectively “pay off” that original loan with your refinance loan.
Whatever savings you may recognize with a refinance loan could be canceled out by lender fees. If you’re unable to refinance without incurring any of these fees, you might want to reconsider.
You’ll actually spend more in the end. Let’s say you have 22 months left on your auto loan, but you’re able to refinance the debt for a 48-month term. Even if your interest rate doesn’t change, your monthly payment amount would drop significantly, freeing up your cash flow for other purposes.
However, this isn’t necessarily a good thing. You’ll want to do the math, especially if your interest rate won’t also be dropping notably, to determine what your actual savings will be. If the refinance loan will simply cost you more money over a longer period of time, it might not be worth doing.
Your credit hasn’t improved. One of the best reasons for considering a refinanced auto loan is if your credit has improved significantly since you first took out your current loan. However, if it hasn’t improved — or if you’ve actually increased your debt burden, made a late payment, or applied for multiple lines of credit since then — refinancing could actually result in worse terms.
It would extend your loan repayment term substantially. When refinancing an auto loan, you often have the choice to get a longer term, stretching repayment further than your current auto loan term. While this can be helpful, however, it could land you in hot water when it comes to your debt and your vehicle’s value.
Cars are continually-depreciating assets. If your refinance loan extends your repayment term too far, you may wind up owing more on the car than it’s actually worth.
An auto loan refinance can be a great financial tool, and often saves borrowers both time and money. However, there is a time and a place to consider refinancing.
It’s important to look at all of your options, as well as your personal financial situation. If refinancing your auto loan would reduce your interest owed, free up your monthly cash flow, and/or help you pay off your vehicle sooner, it’s often worth considering. If refinancing would actually cost you money in the end, or result in you being upside down on your auto loan, it might not be the right move.
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