When to refinance your auto loan and pitfalls to avoid

3 Signs it’s Time to Refinance Your Auto Loan and 5 Pitfalls to Avoid

  • November 28, 2019
  • 4 min read
  • 56 reads

When taking out an auto loan to buy a car, you are not necessarily stuck with that loan until the car is paid off. You can potentially save money by refinancing into a better loan product, so it’s always worth doing your research to find out whether or not refinancing makes sense.

3 Signs it’s Time to Refinance

1 Lower interest rates are available 

This is by far the most popular reason people consider refinancing their current auto loans. If you can borrow funds at a lower interest rate than what you’ve got currently, it might make sense to refinance.

Getting a lower rate means you’ll pay less for your car in the long run, after you take all of your borrowing costs into account. Since the interest rate helps determine your monthly payment, the required payment should also decrease, improving your monthly cash flow as well.

When you can replace your existing loan at a lower rate, it’s best to refinance as early in the loan term as possible. Most auto loans are fully amortizing loans, which means you pay a fixed monthly payment until the auto loan is paid in full. As a result, the majority of the interest costs are paid at the beginning of the loan term.

Using an amortization calculator can show you exactly how much you could be saving by refinancing.

You can reduce your monthly payments

Refinancing your existing auto loan can help to lower your monthly payments, but that may or may not be a good thing in the long run. If your payments decrease as a result of a lower interest rate, you may end up saving money —as long as you refinance toward the beginning of the loan.

However, if you’ve had your current loan for several years, you are going to end up restarting the clock on your amortization period if you stretch the loan term back out. That can end up costing you more over the life of the loan, even though your monthly payments may have gone down.

Your credit scores and credit profile have improved

If your credit scores have gone up, and your overall credit profile has improved since you took out your auto loan, you might be able to do better this time around. You could potentially qualify for a lower interest rate, be able to lock in a fixed-rate loan, or remove an existing co-signor.

Compare your auto loan options now that you’re in a better financial position than you were when you got your current loan.

5 Pitfalls to Avoid When Refinancing

  1. Going backwards to a longer term: Taking out a longer term loan inevitably leads you to pay more for your car loan over time. Though it may be enticing to stretch your payments out over a longer period of time, especially if it lowers your monthly payments in the short-term, the overall cost of a long-term loan is higher.
  2. Not taking depreciation into account: If you extend your loan term, and your car decreases in value more quickly than you’re paying off the new loan you could find yourself “upside-down” and owing more than the car is worth. This is particularly problematic if something should happen to the car.
  3. Paying prepayment penalties: Though prepayment penalties are less common on auto loans these days, they do still exist. These are fees charged by your current lender for paying off the loan before the end of the term, and they can really cut into your rate savings. Be sure it won’t cost you extra to pay of your current loan early.
  4. Missing a payment: Any delays during the refinance process can throw off your payment schedule, and having a missed payment can negatively impact your credit and even your ability to complete the refinance. As with any loan, continue making your payments until you confirm with both lenders, current and future, that your old loan is paid off and your new loan term has begun.
  5. Waiting too long: The newer your car is, the easier and less expensive it will be to refinance. In fact, many lenders may not even want to refinance your car if they determine it’s too old — typically 7 to 10 years or more. Interest rates are also better for new or nearly-new cars than they are for used cars.

Bonus: Gather this info before starting your refinance

  • Details of your current loan, including the current lender information, account number, and current loan balance.
  • Vehicle information including the make, model, year and VIN.
  • Your income and asset documents, including pay stubs, tax returns, and recent account statements.
Author Lauren Scungio

Lauren is a mortgage professional and personal finance writer in Scottsdale Arizona. She enjoys creating interesting and educational content geared towards spreading financial literacy and helping people make the best financial decisions.

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Last Updated: February 2, 2020

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