Pros And Cons Of Refinancing A Car

Pros of Refinancing Your Car

The primary goal of refinancing your auto loan is often to get a lower interest rate. There are two main ways of getting a lower interest rate on your loan. The first option works if your credit score has improved since you took out your loan. If you've been on time with your car payments, lenders will view you as a lower-risk investment and may offer you a lower interest rate. Alternatively, fluctuations in the market can also result in interest rates trending downward overall. Refinancing at a lower rate will save you money in interest throughout the loan.

Another potential benefit of refinancing your car is the ability to lower your monthly payment, which frees up cash you can use for other expenses. Unfortunately, you'll end up paying more in interest if you refinance your loan for a longer term without getting a lower interest rate.

Conversely, you can refinance your loan to shorten the term and pay off your car sooner. This will increase your monthly payment, but will reduce the amount of interest you will owe and help you become debt-free sooner.

Cons of Refinancing Your Car Loan

Refinancing your car loan to lower your monthly payment can be a tempting proposition. However, extending your loan's term to lower the monthly cost can increase the total amount of interest you owe. Sometimes, this is necessary, but temporarily improving your financial situation by lowering your payment can ultimately harm your finances if the additional interest outweighs the monthly savings.

Additionally, extending your loan term will force you to stay in debt longer than you had originally anticipated. This course of action should only be considered when you need to free up cash for other expenses or in case of emergencies.

You also run the risk of going upside down on your car loan when you refinance, which is when the amount you owe is higher than what the car is worth. This is something you should be mindful of when considering refinancing, especially if you're financing a vehicle that could depreciate quickly.

Applying for refinancing also typically entails a hard credit inquiry, which will cause a small hit to your credit score.

When Should You Refinance Your Car?

• Your credit situation has improved. In some cases, a better credit score is your ticket to qualifying for different rates and terms on your auto loan. In fact, a good or improved credit score is often one of the requirements of refinancing.
• Your interest rate is really high. A high interest rate is a common reason for attempting to refinance your auto loan. If you didn't qualify for a rate as low as you thought you would, you can always shop around for refinancing rates to see who can help.
• You want to remove a cosigner. If you didn't have the credit score to qualify for an auto loan on your own, you may have had to get a cosigner to help. If your situation has improved and you're able to qualify for lending on your own, the only way to remove a cosigner from your loan is to pay it off or refinance.
• You need to lower your monthly car payment. For the most part, this should be the only reason for refinancing your car loan. If you're paying too much each month, you can opt to refinance for either a lower interest rate, a longer loan term, or both. Be aware that only a lower interest rate can help you save money in the long run. If you extend your loan, you'll pay less each month, but end up paying more in interest charges over the life of your loan.

When Shouldn't You Refinance Your Car?

• You want a shorter loan term. A shorter loan term will increase your monthly payment but may save you money overall in interest charges. But you don't need to go through the hassle of refinancing. You get the same results by just making a larger monthly payment. To see how much more you should pay, simply divide your remaining loan balance by the number of months you want to pay. The answer is your new monthly payment. If you find your situation changes, you're not locked into a new contract with a higher payment, you can simply go back to making your minimum payment without risking default.
• You have negative equity. Refinancing isn't possible unless there's some value in your vehicle. To refinance, your car must be worth at least as much as you owe on the loan. To find out if your vehicle has equity, check website valuation tools such as Kelley Blue Book and NADAguides to answer a few questions and get an estimated value for your car. Then, compare this amount to a 10-day payoff amount from your lender.
• You have pre-payment penalties on your auto loan. These aren't very common anymore, but if you're stuck with a contract that uses them, refinancing may not be worth your effort, literally. Some loans impose fees when they're paid ahead of schedule, even in cases of paying off the loan for refinancing. In this case, any equity you have may not be enough to offset the charges, which vary by lender. These penalties must be paid when you close the loan, and if you don't have savings, you could be taking a loss by refinancing.

Is It Ever a Good Idea to Refinance Your Car?

A big part of how much you end up paying for your auto loan is interest. The higher your interest rate, the more it costs you to borrow money. This means you'll pay more in interest charges over the life of your loan than someone with a lower interest rate.

If you originally took out a bad credit car loan or qualified for an interest rate that's higher than you wanted, refinancing to a lower interest rate can help you save money.

According to Experian's State of the Automotive Finance Market report in the fourth quarter of 2024, the average used car loan amount was $28,675, and the average loan term was 69.5 months. Using this real-world example, let's look at how refinancing can save you money. For our example, we're rounding to a five-year loan term of 60 months.

$28,675 loan, 15% interest rate, 60-month loan

• Monthly payment: $682.18
• Interest paid: $12,255
• Total Cost: $40,930

$28,675 loan, 9% interest rate, 60-month loan

• Monthly payment: $595.25
• Interest paid: $7,039
• Total Cost: $35,714

As you can see, taking out a bad credit car loan can be very costly. If you have improved your credit and can qualify for a lower interest rate, it could save you thousands over the life of your loan.

Final Thoughts

In today's market, where the costs of vehicles are on the rise, qualifying for the lowest possible interest rate can be key to saving money. If you have improved your credit over the past year or two and have kept up with your loan payments, you may be eligible to refinance your car to save money.

If you're ready to look for a lower interest rate for your car loan, we want to help. Simply fill out our fast, free, auto loan refinancing request form to get started.

FAQ

What is Refinancing a Car?

Refinancing a car refers to replacing your current auto loan contract with a new one. This way, you're paying off the same car, but with a new loan.

Does Refinancing a Car Hurt My Credit?

You will likely be subject to a hard credit inquiry, which will put a small dent in your credit score.

Should I Refinance My Car?

If you fall into one of the scenarios mentioned above, refinancing could be a good way for you to save on your auto loan.