Refinancing a car loan can be a good idea when the situation is just right. Since the process of refinancing an auto loan has different outcomes for borrowers in different situations, you have to look into what you want to accomplish and crunch the numbers to see if it's a good idea.

When Refinancing a Car Loan is a Good Idea

There are two common situations when refinancing makes the most sense: when you can get a lower interest rate to save money, and when you absolutely need a lower monthly payment.

Refinancing a Car Loan to Lower Your Interest Rate

Is Refinancing a Car Loan a Good Idea?When you can get a lower interest rate by refinancing, it's almost always a no-brainer. This allows you to pay less in interest charges over the term of the loan, which means you save money in the long run.

Keep in mind that getting a lower interest rate is only possible when your credit has improved from the time you originally financed the vehicle, or when rates have dropped in the overall marketplace (keep in mind that interest rates are currently on the rise).

Say you took out your auto loan when your credit was less than perfect, and you got an above average interest rate as a result. If your credit score has improved since then, it's often possible to qualify for a lower interest rate and save money for the remainder of the loan. To see this in action, let's look at an example: if you originally qualified for a 12 percent interest rate, and have $10,000 and 36 months left on your loan, refinancing and getting a four percent interest rate results in these savings:

Interest RateMonthly PaymentInterest PaidTotal Cost
12 percent $332.14 $1,957.18 $11,957.18
4 percent $295.24 $628.63 $10,628.63

In this scenario, refinancing helps you save a good chunk of change, making it absolutely worth it. However, in situations where you're not able to get a much better rate, the financial impact won't be as significant. Also, if you refinance, get a lower rate, but extend the loan term, the longer length might offset any savings (although the monthly payment will drop).

Refinancing When You Need a Smaller Car Payment

If you're having trouble affording your monthly car payment, refinancing is also a solution that can help. Say your financial situation has changed – perhaps due to a lower paying job, an unforeseen new bill that you have to budget for, or any other reason – and now you have less room in your monthly budget. By refinancing and extending the loan term, you can get a lower monthly payment to free up some money.

However, you should keep in mind the long-term drawback of doing this: you end up paying more in the long run. When you extend a loan term, it leads to more interest charges and, therefore, a higher total cost. It's only a good idea to refinance to get a lower payment if it’s absolutely necessary.

Let's look at another example to see what we're talking about in action. If you have an eight percent interest rate and have $8,000 and 24 months left on your auto loan, here's what extending the term to 48 months does:

Loan TermMonthly PaymentInterest PaidTotal Cost
24-month loan $361.82 $683.63 $8,683.63
48-month loan $195.30 $1,374.60 $9,374.60

As you can see, the trade off of extending the loan for two more years is paying nearly $700 more in interest charges, although you free up over $166 in additional monthly cash.

Keep in mind that these savings are reduced if you're only able to qualify for a higher interest rate when you refinance. On the other hand, it may be possible to extend the term and get a lower interest rate when do so, which can help even more. Just make sure you understand the consequences and do some research and loan shopping to see the terms you're able to qualify for if you want to refinance.

When Refinancing an Auto Loan is a Bad Idea

On the other end of the spectrum, there are many situations where it's a bad idea to refinance your car loan. If your loan is nearly paid off, there may not be a lot of financial benefits to doing this. Or, if your car is old and has high miles, it might not qualify for refinancing.

Another scenario where you should avoid refinancing is when you're upside down. Vehicles depreciate in value, often at a faster pace than you're able to pay down the principal of your loan. This leaves you owing more on the loan than your car is worth, meaning you have negative equity or are underwater. You either won't be able to find a lender who'll let you refinance, or they'll demand cash upfront to pay off the negative equity before you can proceed.

The Bottom Line

Refinancing a car loan is typically only a good idea when you can get a lower interest rate or need a lower payment by extending the term. Make sure you understand what you're trying to accomplish, consider the short- and long-term impacts of doing so, and do the math to see if it'll be worth your while.

While Auto Credit Express can't help borrowers who need to refinance, we can help those who need car loans find a dealer. We work with dealerships all around the country that specialize in helping consumers dealing with imperfect credit get financed. Get our simple and free process started right now by completing our auto loan request form online.