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Refinancing a car loan can be a good idea for some drivers.
Refinancing an auto loan means replacing your current car loan with a new one. Your new auto loan pays off the old one, meaning you’ll have an all-new loan agreement — including a new APR, which is your interest rate, and a new loan term, which is the amount of time you have to pay off the loan.
There are a number of reasons why a driver might want to refinance a car loan, but it’s usually a cost-cutting measure. Refinancing from a loan with a high interest rate to one with a lower rate can be a good way to save money. If your monthly loan payments are too expensive, refinancing to an auto loan with a longer loan term can get you lower monthly payments, but may cost you more over the life of the loan.
Refinancing a loan can mean additional fees, too, and may damage your credit score, so if you’re wondering whether or not you should refinance your auto loan, it’s important to weigh the pros and cons — refinancing is definitely not an automatic money-saver.
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A car loan is a type of secured loan mean to help you buy a vehicle. Car loans work much the same way as other types of loans: An institution agrees to lend you money to buy a car, and you agree to pay back that amount over time, plus interest. You can get a car loan directly from a bank or a credit union, or you can go through a car dealership.
Wherever you get your loan from becomes your lienholder. Your lienholder is the party that owns your debt, and if your original lender sells your loan to another party, they become your new lienholder.
When you take out a car loan, your car itself is the collateral. That means that if you don’t make your loan payments, your lienholder can take possession of the vehicle.
For some drivers, refinancing an auto loan makes financial sense. Some of the benefits to refinancing your car loan include:
This might be the most obvious reason to refinance. If interest rates have dropped since you initially took out your car loan, it makes sense to refinance. A loan with a lower interest rate, even if it seems like a small difference, can save you a lot of money over time.
You may also be able to get a lower interest rate if your credit score has improved significantly since you first took out your loan.
The better your credit, the better loan offers you’ll get, so if you’re in a better financial situation than when you first took out your car loan, consider shopping around to see if you qualify for lower rates.
Even if you can’t refinance for a lower interest rate, if your monthly payments are too high, you can look into refinancing with a new loan that has a longer term.
Going from a 36-month loan term to a 72-month loan term won’t save you money overall — longer term lengths usually mean you wind up paying more over the life of the loan — but it will lower your monthly payments. If you’re struggling to keep your head above water each month, lower monthly payments might be helpful.
Some banks may offer special discounts for existing customers who choose to refinance a car loan with them. Check with your current bank to see if they can offer special rates on refinancing auto loans.
As we mentioned above, while refinancing an auto loan can be a good way to save money, it’s not an instant win for every driver. There are some cons to refinancing an auto loan, including:
Refinancing your auto loan makes sense if you can save money, but it’s not right for everyone. If you’re almost done paying off your current auto loan, refinancing to a loan with a lower rate won’t save you much money since you’ve already paid most of the interest.
Lenders may also place some restrictions on refinancing. For example, some banks and other lending institutions won’t refinance your loan if your vehicle has above a certain number of miles or is more than ten years old.
If you need your credit score in tiptop shape for any reason, you may want to consider holding off on refinancing your auto loan. When you apply for a new loan, lenders will conduct a credit inquiry, which can take some points off your credit report.
If you’re just straddling the line between “good credit” and “great credit,” the process of refinancing your loan might keep you from that better score. However, as with all loans, making your payments in full and on time is good for your credit score, so taking a small hit to your credit score may be worth it in the long run, if it helps you avoid missing any payments or defaulting on a loan.
It’s also worth noting that if you shop around with a few lenders, it won’t necessarily harm your credit score anymore than if you just applied with one. If multiple auto lenders conduct hard inquiries within a certain time frame, it will only count as a single inquiry, and the damage to your credit score will stay minimal.
Refinancing your auto loan may involve fees that make it more expensive. Your current loan may charge you a prepayment penalty, which is a fee for paying off your loan early.
There may also be small fees for re-registering your auto loan with the state and for transferring the lien, but those tend to be negligible.
Refinancing an auto loan is a much faster process than, say, refinancing a mortgage. You should have all the necessary info on hand, including info about your current loan, like your monthly payment, your interest rate, and your loan term. You’ll also want to check with your current lender to see if you’ll have to pay a prepayment penalty.
Just like any time you apply for a loan, you should apply with multiple lenders and then compare loan offers to see which is the best one (most banks and online lenders make it quick and simple to apply online). If you’re looking to save money, make sure you’re considering loan term as well as interest rate.
Once you’ve crunched the numbers and decided on the loan that’s right for you and your bank account, you’ll sign a new loan agreement. Your loan will pay off your own loan and then you’ll start making your new monthly payments.
Policygenius’ editorial content is not written by a certified financial planner or advisor. It’s intended for informational purposes only and should not be considered legal, financial, or investment advice. Consult a professional to learn what financial products are right for you.
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