women fastening seatbelt in car

Top 4 Things to Consider Before Refinancing Your Car

May 08, 2020
By Mariclare Cranston, Content Specialist

Should I Refinance my Car Right Now?

Refinancing an existing car loan is one way to save some money and lower your debt. By refinancing you may be able to secure a lower interest rate – potentially lowering your monthly payment – or shorten your term – meaning you’re paying less overall and will eliminate that debt faster. There are important factors to weigh, though, before hopping on the refi train.

We’ve rounded up the top four things to consider before talking to your bank or credit union about a refi.

1. Your current loan status impacts potential savings from refinancing. 

If you’re underwater – also known as upside down – on your car loan, it means that you currently owe more than the car is actually worth. Having negative equity is a tricky spot to be in and you’ll want to carefully discuss your options with any potential lenders, including your current lender, before making a refinance decision.

If your credit is good, you may be able to refinance your car loan at a lower interest rate; don’t be tempted to opt for lower monthly payments, though. Doing so will extend the life of your loan and could put you further underwater on your loan, especially since cars lose their value year after year.

Instead, opt to shorten the term, or length, of your loan. While your monthly payments may not go down, you’ll pay your car loan off faster which will help you escape the negative equity.

► Pro Tip: If you’re underwater on your loan and your credit doesn’t warrant a refinance, try paying a bit extra on your loan each month. You can talk to your lender about how much extra will help you get to a place where you’re not holding negative equity. 

2. Your credit impacts your ability to refinance.

Like so many of your financial decisions, your credit is going to matter. If your credit is good, and interest rates have dropped since you purchased your car, you will likely be able to refinance your loan at a lower rate. This could lower your payment and save you money on interest.

Even if rates have not gone down drastically, refinancing your car can still save you money. If you’ve paid a chunk of your car off, refinancing can lower your overall balance, saving you money with lower monthly payments or a shorter term.

Refinancing to either shorten or extend your term can also save you money. Let’s look at two examples.

In this example, you can see that by refinancing for an extended (longer) term after one year of payments you can reduce your monthly payment. You will end up paying more towards interest, but if you need to improve your monthly cash flow this could be an option for you. 

Refinancing payment savings example

In the next example, refinancing after one year of payments is saving you money by shortening the term, saving you in overall interest paid.

Refinancing and shortening term

► Pro Tip: Ideally, you don’t want to add months or years to your car loan. If you’re in serious need of extra cash, though, refinancing your loan for a longer term could lower your monthly payments and improve your cash flow.
If your credit isn’t as healthy as it should be, refinancing your car loan may not make sense right now because you may be not able to secure a favorable interest rate. Take a look at this article for information on how you can improve your credit. Even if refinancing doesn’t work right now, improving your credit over the next few months can make that opportunity available to you in the future.

NEED MORE INFO ON YOUR CREDIT? Check out our Understanding Credit presentation. This recorded webinar walks you through what credit is, what you’re potentially doing to hurt it, and how to improve it. Watch now!

3. The age of your car impacts your refinance savings.

How old is your car? Believe it or not, its age will help you decide whether refinancing your car right now is the best move. Generally speaking, the older your vehicle is, the higher your interest rate will be. This means that if you originally purchased a used car, and it’s even older now, your refinanced interest rate may end up being higher. Talk to potential lenders and your current financial institution to get a good understanding of whether refinancing would make sense with the age of your car.

On the flip side of that, refinancing too soon after the purchase may not be the best move, either. When you applied for your original car loan, the lender ran your credit which likely resulted in a bit of a dip in your score. Give yourself at least six months to recover from that inquiry before you apply for a refinance, and keep in mind that opening a new loan – even a refinance – will impact your credit.

Is this your first car loan? Wait even longer than six months. Lenders are going to want to see at least a year of good payment history on your car loan.

How long to wait to refinance your car

4. Your mileage impacts your potential refinance savings.

Have a thing for road trips? If you’ve racked up some serious miles, it may not make sense to refinance your loan. The more miles a car has, the more its value has depreciated or gone down. And the less value a car has, the less likely a lender will be to refinance.

If you’ve put more than 90,000 miles on your car, your lender may be hesitant to refinance your loan, or you may not get an interest rate that would save you money. Your best bet is to talk to your lender – and several others if need be – to see if refinancing is a viable option.

Here’s when refinancing may not be the best option.

While you can potentially save money by refinancing, there are a few reasons to hold off. First, check the terms of your original loan. Does it have a prepayment or early repayment penalty? Some loans include this fee to recapture interest the lender will lose by the loan being paid off sooner than anticipated. If your original loan does include this fee, you’ll want to weigh it against any savings you may realize with a refi. Does the cost outweigh the benefit? If not, refinancing may not be the right option.

Another thing to consider is your future need for credit. For example, if you plan on applying for a mortgage soon, you’re going to want your credit to be as squeaky clean as possible. Applying for a refi means your lender will pull your credit, what’s known as a hard pull. This could cause your credit score to temporarily dip. And when you’re trying to lock in a favorable mortgage rate, every point on your credit score is going to matter.

Like any financial decision, it’s important to weigh the pros and cons of refinancing against your own personal financial situation and goals. Perhaps the most important step is talking to your lender; they can provide you the options that best meet your specific needs.

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