Refinancing your car loan can seem like a great option if you’re low on cash or have found a better interest rate from a different lender.
However, you should consider several factors before going through with the decision. This includes your credit score, the terms of the existing loan, current interest rate, and more. As a rule of thumb, refinancing your car loan works in your favor if it lets you save money over the loan’s term. This could reduce your monthly payments and give you more wiggle room to meet other financial obligations.
Even if you don’t find a better interest rate, you may be able to negotiate a longer repayment period, which can also lower your monthly payment – although this may increase the total interest payments you pay for the loan.
So why should you refinance your car loan? Here are six reasons why.
1. To Reduce Your Monthly Payments
Life has a way of throwing curveballs at us every now and then; it could be a surprise medical bill, a natural disaster, or a layoff. Refinancing your car loan could help you lower your monthly payments to free you up for other financial obligations. For example, if you owe three more years on your current loan, you might be able to extend the term to six years and, as a result, have more available cash.
Adding four more years could significantly reduce your monthly payments, as long as you were able to negotiate a favorable interest rate.
Changing your lender is also a good option, especially if you are able to secure a better interest rate.
2. Increase Your Cash Flow
If your car is worth more than what you owe, then you have what is known as ‘positive equity.’ In this case, you may be able to refinance the loan to access more cash flow. For example, suppose you have owned the car for four years. The car is currently worth $10,000, and you still owe $4,000 on your loan. You need cash for an emergency payment.
One option is to refinance the car for $9,000. Suddenly, you have up to $1,000 of new money available to spend once the new loan wipes off your previous $4,000 balance. The $1,000 can now be used to fund other things.
A word of caution: Cars continue to depreciate and can easily lose over 20% of their value within the first year of ownership. Never owe more on your car than it is worth.
3. You’ve Improved Your Credit Score
Even if the interest rate hasn’t changed much since signing for your initial loan, improving your credit score may be enough to secure a lower interest rate. A higher credit score can help you get more favorable loan terms. This only works if you have improved your credit score since you first financed the car.
4. The Dealer Gave You a High-Interest Rate
It isn’t uncommon for auto dealers to quote high-interest rates, more so than banks and credit unions. So if you bought your car through dealer-arranged financing, then refinancing your car may be a better option if it translates into a lower interest rate.
5. You Want to Remove a Cosigner
You might have used a cosigner to get approval for your car loan. Since then, you’ve improved your credit score and credit history, and you’ve also increased your monthly income. If this is the case, now may be the right time to refinance the auto loan in your name with no cosigner. You may want to remove your cosigner from the auto loan if their credit score is low. This will ensure that their lack of payments doesn’t affect your own credit score.
6. You Are Making More Money
You’ve managed to improve your monthly income since you first signed your auto loan. Now you want to refinance your car to a shorter term to pay the loan off soon. Lenders favor lenders with better income and are more than happy to refinance. This arrangement may be for both you and the lender. It will also reduce the amount of interest you pay in the long run. A win-win situation for both.
7. You Found a Better Deal at Another Lender
Found a better interest rate at another lender? Rate shopping is only effective if your loan term isn’t near its end. If you found a lower interest rate than what you currently have, refinancing your auto loan could help you save money in the long run and may also reduce your monthly payments.
Caution: It’s not advisable to refinance your auto loan if you’re far along in your original loan’s repayment. Thanks to the amortization process, your interest charges will reduce over the life of the loan. As a result, refinancing your auto loan is more beneficial if you’re in the earlier stage of repaying the original loan. If you’re somewhere in the middle, consider doing some quick math to see which loan term saves you more money.
The main reason people refinance their auto loans is that they found a lower interest rate that lets them save in the long run. Technically speaking, you could refinance your auto loan whenever, even hours after you first buy the car.
But depending on your repayment schedule, the savings you make will vary. Consider hiring an expert to do the math for your situation and see how much refinancing can save you.