Is Refinancing Your Car Loan Worth It?

It depends on your financial situation and current market conditions – refinancing could get you a loan with better terms, or it could cost you more than you would save.

In 2023, the average price of a new vehicle reached nearly $50,000. Most people don’t have $50,000 in cash available, so banks, credit unions, and financing companies originate millions of auto loans each year. When you borrow money to buy a vehicle, your monthly payment depends on several factors, including the purchase price, the interest rate, and the number of months on the loan.

If you don’t qualify for favorable loan terms when you need a new vehicle, one option is to take out a loan and then refinance it later. But is it good to refinance your car? It depends on your financial situation and current market conditions. Learn more about refinancing here to determine if it’s right for you.

What Is Refinancing?

Refinancing is when you replace your existing auto loan with a new loan. For example, if you take out a $30,000 loan from Company A, you may want to refinance with Company B a year later. If Company B approves your application, you use the funds from the new loan to pay off the old loan.

The main purpose of refinancing is to take advantage of better loan terms. If you refinance at the right time, you may be able to lock in a lower interest rate, reduce your monthly payment, or shorten your loan term, all of which can help you save money in the long run.

Is It Worth It to Refinance Your Car?

So, is it a good idea to refinance your car? It depends on your circumstances. Before you apply for a new loan, consider these factors.

Benefits of Refinancing

The biggest advantage of refinancing is that it gives you an opportunity to get a loan with better terms. For example, if you had a middle-of-the-road or bad credit score when you took out your original loan, you may have an interest rate in the double digits. If your score has improved since then, you may be able to refinance at a much lower rate.

If you have a loan with a 48-month term, refinancing to a loan with a 60-month or 72-month term may help you reduce your monthly payment, as you’ll have more time to repay the lender. This is helpful if you’re currently having trouble making your monthly payment.

Refinancing also lets you choose a loan with a shorter term, reducing the amount of interest you pay over time. For example, if you refinance from a 60-month term to a 36-month term, you may save thousands of dollars in interest.

Drawbacks of Refinancing

Although refinancing has several potential benefits, it doesn’t always make sense. One of the biggest drawbacks of refinancing an auto loan is that it may cost you more than you save. For example, some loan contracts include prepayment penalties, so your lender may charge you a fee to pay off your loan earlier than agreed.

Some loans also include precomputed interest. This is when a lender calculates how much interest you’d pay over the full loan term and then adds that amount to your principal balance. If your loan comes with precomputed interest, refinancing won’t save you much money, as you’ll still have to pay the entire interest amount.

When you refinance an auto loan, you may also have to pay additional fees. For example, some states charge a re-registration fee if you switch from one lender to another. Before you refinance, make sure you understand how these fees are likely to affect your potential savings.

Should You Refinance?

It may make sense for you to refinance in the following situations.

Your Financial Standing Has Improved

If your financial situation has improved drastically since you originally took out an auto loan, refinancing may help you take advantage of much better loan terms. For example, consumers in the subprime category (credit scores ranging from 501 to 600) typically pay around 12% interest on auto loans for new cars.

In contrast, consumers in the prime category (scores of 661 to 780) average just 6.88% for new car rates. Therefore, if your score has increased significantly since you borrowed the money, you may be able to refinance at a much lower rate. Note that interest rates change based on market conditions, so you need to check current rates before you apply for an auto loan.

You Are Having Difficulty Making Payments

If you can’t afford your monthly payment, refinancing may make it easier to meet your financial obligations. For example, if you originally took out a loan with a 36-month term, you have just three years to pay back the full amount borrowed.

Even if you managed to secure a loan with a 0% interest rate, you’d have to make payments of $833.33 per month to repay $30,000 in 36 months. Refinancing allows you to choose a loan with a longer term, which may reduce your monthly payments.

There Have Been Market Changes

As noted previously, interest rates change based on market conditions. If rates have decreased significantly since you took out your original loan, refinancing may help you save a substantial amount of money. For example, if you originally agreed to a 10% interest rate, you may be able to slash that to 5% in a favorable economic environment.

Alternatives to Refinancing a Vehicle

Refinancing doesn’t make sense if you’ve already paid off most of your original auto loan. You may also want to avoid refinancing if your original loan has precomputed interest or prepayment penalties.

If you still need to lower your monthly payment, consider these alternatives to refinancing:

• Vehicle trade-in: If you just can’t afford your monthly payment, it may be time to trade in your vehicle for something less expensive. For example, if you’re currently driving a luxury SUV, you may be able to purchase a mid-sized sedan for a much lower price.
• Private-party sale: Another option is to sell your vehicle to a private party and use the proceeds to purchase something more affordable.
• Loan modification: Some lenders offer loan modifications, which are changes to the terms of your original loan. If you’re struggling to make payments, contact your lender right away. You may be able to skip a payment or make lower monthly payments for a short amount of time, giving you more wiggle room in your budget.

Refinancing involves taking out a new loan and using the funds to pay off an existing loan. Therefore, you generally need to have good credit to make the process worthwhile. If you haven’t checked your credit in a while, request a free credit score from Credit.com before you apply for a new loan.

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