If you have a car loan with high monthly payments and interest rates, you’re probably wondering how you can lower it. Auto refinancing might just be what you’ve been looking for. Refinancing your car loan may save you money that you can put toward other financial obligations.
So, how does auto refinancing work? Find out here if refinancing is right for you.
What is a Car Loan?
A car loan or an auto loan is a sum of money secured by the car you plan to purchase. In other words, the car serves as collateral for the loan. That means if you fall behind in your loan repayments or default, the lender can repossess the car.
Car loans work pretty much like other types of loans. Before you take out an auto loan, you enter into an agreement with the lending institution to repay the loan over time plus the interest. The lender retains the ownership of the vehicle until you make the loan repayments in full.
You can get a car loan directly from a bank, credit union, or through a car dealership.
What is Auto Refinancing?
Auto refinancing is replacing your current car loan with a new auto loan, typically with a new loan term and annual percentage rate (APR). These loans are often secured by a car and paid off in fixed monthly installments over a set period of time, usually a couple of years.
People refinance car loans for various reasons. Most of the time, the goal is to save money over time. You can refinance to lower monthly payments, reduce interest rates by refinancing a high-interest loan to a lower-interest loan, remove or add a co-signer to your loan, or adjust loan terms. No matter the reason for refinancing, it’s essential to understand the possible outcomes.
How Does Auto Refinancing Work?
When you refinance your car loan, you’re virtually replacing your current loan with a new one. Your new loan pays off the existing car loan, and after that, you start making monthly payments on your new loan.
Typically, the new loan comes with more favorable monthly payments, interest rates, and loan terms. Depending on the lending institution, you could save money over the course of the loan term.
You can apply for auto refinancing at an institution of your choice, provided that you have all the paperwork needed. But before taking the plunge, it’s crucial to weigh the pros and cons of auto refinancing to make an informed decision.
Pros of Auto Refinancing
Refinancing a car loan comes with various benefits, including:
Lower Your Monthly Car Payments
Refinancing can help lower your car loan monthly payments in two ways 一 getting a lower interest rate or extending your loan term. However, extending your loan term could increase the total amount of money you’ll need to pay back. So, the only situation where you may benefit when you extend the term of your loan is if your lender accepts lower monthly payments.
Reduce Your Interest Rate
Interest rates heavily impact the amount of money you’ll pay over the loan term. Let’s say you’ve improved your credit score since you took the loan; you can consider refinancing as you may qualify for lower interest rates. A lower interest rate can save you hundreds of dollars in the long run.
Change Your Car Loan Terms
The ability to adjust car loan terms is another key benefit of auto refinancing. If your monthly payments are too high, refinancing with a new loan with a longer-term can lower it. The only downside of longer-term loans is that you may end up paying more than you would if you took a shorter-term loan.
Remove or Add Someone as a Co-Signer to Your Loan
Refinancing can also help you meet your personal needs, such as removing or adding a co-signer to your loan. It’s easy to do this since refinancing means new loan terms.
Cons of Auto Refinancing
While auto refinancing may seem like a good deal, it comes with trade-offs.
Can Affect Your Credit Score
The most obvious disadvantage of auto refinancing is its impact on your credit score. Whenever you apply for a new loan, lenders will make a hard credit check to determine your ability to repay a loan. Hard inquiries appear on your credit report and can affect your credit score. That said, on-time payments on your new loan can correct for this over time.
Additional Fees
Refinancing often means additional fees, such as application, origination, and transfer fees. You may also pay a prepayment penalty for paying off your current loan early. Not all lenders charge these fees, though. Ensure that you read the fine print of your existing agreement to know whether there are any extra fees.
Not For Everyone
Refinancing doesn’t make sense for everyone. It only makes sense if it can help you to save cash. If you’re close to paying off your current loan, refinancing to a new one may not be in your favor.
Plus, lenders may impose restrictions on refinancing. For example, lending institutions can refuse to refinance your car loan if it has exceeded a specific mileage.
When Does It Make Sense to Refinance?
Refinancing may not work for everyone, but it can benefit you in some scenarios. You may want to consider auto refinancing in the following situations:
Interest Rates Are Lower Since You Took Out Your Original Auto Loan
If you purchased a car when interest rates were high, consider refinancing your car. Refinancing can help you save a lot of cash over the life of the loan, provided that you do not extend your loan term.
Your Financial Situation Has Improved
Many factors go into determining auto loan rates, including your credit score and debt-to-income (DTI) ratio. Bolstering your credit history and lowering your DTI ratio can help you get more favorable terms when refinancing your car loan.
You Didn’t Get a Good Offer the First Time
When applying for a car loan for the first time, you may have gotten an offer that is not suitable without your knowledge. This happens, especially if you got your original loan from a car dealership, as they often charge higher rates.
It’s Hard Keeping Up with the Bills Each Month
If your monthly payments are so high that you start falling behind your monthly bills, it’s time to refinance your car. Though you may not get a lower interest rate, an extended repayment period can help lower your monthly payments.
