The process of refinancing a loan—or, replacing one or more current loans with a new one, sometimes with a new lender—can prove beneficial in a number of circumstances. Deciding whether or not to replace your current loan means considering many factors, including current interest rates, your current credit score, the terms of your existing loan, your income, and more. Understanding these factors will help you best assess whether or not refinancing your car loan has the potential to save you money. There are, however, situations where it would prove more beneficial to remain with your current loan.
When Should You Consider Refinancing a Car Loan?
The biggest reason to consider auto loan refinancing should be cost savings. You may want to consider refinancing if
- Rates have dropped. Most interest rates for auto loans will fluctuate, but if a significant amount of time passed since you signed your current loan, you may qualify for a lower rate
- Your credit has improved. Even if interest rates don’t change, if you’ve been able to improve your credit score since taking out your current auto loan, better terms and a better interest rate may be available to you.
- You originally financed through a dealership. Car dealers tend to charge higher interest rates over a bank or credit union. Simply refinancing with a new lender may mean lower rates for you.
- Your financial situation has changed. Refinancing your car loan can also provide lower monthly payments. If you have a tighter budget than when you originally took out your current car loan, you can refinance your loan to extend over a longer-term—for instance, from 36 months to 48 months. However, it is important to keep in mind this means you will pay more over the life of the loan, despite the lower monthly payments.
- You want to change your loan term. A car loan goes "underwater" or "upside-down” when the owner owes more on repayment of the current loan than the car itself is actually worth. Financial institutions will usually avoid refinancing if the borrower owes more than the car’s value, but refinancing to shorten your loan term could prove beneficial. On a shorter-term with lower interest rates, more of your payments will go toward your principal (the initial loan amount, without interest), which will help you recover equity quicker.
How Do You Know If Refinancing Will Save You Money?
If you do meet any of the above criteria, consider comparing the following first to determine if it is worth it
- Current loan balance
- Remaining loan term vs new loan term
- Are there any refinancing fees
- Total interest remaining on current loan
- Total interest on the new loan term
For example, if you currently owe $20,000 at 8% with 36 months remaining and can refinance to 6% for 40 months, how much would you actually save in the long term?
When Is Refinancing a Car Loan Not Worth It?
While it is important to understand how refinancing your car loan can benefit your wallet, it is also important to understand when it would be in your best interest to remain with your current loan and lender. If you find your current situation described below, it may not be the ideal time to refinance your car loan.
- You’re near the end of the loan. Through the process of repaying your loan, interest charges gradually decrease over the life of the loan. Therefore, refinancing a loan holds the most potential to save you money when you’re in the early stages of repaying your initial loan.
- The new rate isn't meaningfully lower. Marginal changes will only extend your loan term for not much savings.
- Your vehicle has depreciated significantly. An old car with high mileage may not be valuable enough to lenders willing to issue a loan with better rates than you currently have.
- You have a prepayment penalty. Some lenders charge a fee for paying off a car loan early. Before you refinance your loan, make sure you are clear of any such terms, conditions, and potential fees with your current loan.
- You would substantially extend the loan term. Is another 12- 24 months worth the savings? Again, is there any savings still at that point?
- You bought your car less than 6 months ago. While you are able to refinance your loan at any point you wish, if you have a new car, it may be best to wait 6 months to 1 year in order to build a positive repayment history, and to allow your credit score to benefit from your consistent payments.
Still unsure about whether or not you should refinance your car loan? Try out TDECU's auto loan calculator to determine how much you stand to save.
Sources:
https://www.bankofamerica.com/auto-loans/when-to-refinance-a-car/
https://www.bankrate.com/loans/auto-loans/upside-down-car-loan/
https://www.lendingtree.com/auto/paying-principal-on-car-loan/#whatistheloanprincipal