Auto Loan Refinancing 5 Things To Know

Auto Loan Refinance - Five Things to Consider Before Refinancing Your Car Loan

5 Things to Know When Refinancing an Auto Loan

Refinancing your auto loan is a major decision, but it’s often the best way to deal with car-related debt. Without refinancing, you could be forced to pay late fees or even default on the loan if you’re unable to make payments.

This article will cover some of the most important things you should know if you’re considering refinancing your auto loan. Keep in mind that every situation is different—this strategy is good in some circumstances, but in others refinancing could result in a higher total cost compared to making on-time payments toward the original balance.

1. How Auto Refinancing Works

Refinancing an auto loan is similar to refinancing any other form of credit—you are essentially taking out a new loan to pay off your existing balance.

This could be because you’re having trouble keeping up with your payments.  While you’ll likely spend more in interest, you’ll save money by avoiding the costs that come with making late payments.  In this case, you might be able to find a loan with a longer term, allowing you to make smaller payments each month over a longer period of time.

Of course, if you’re a strong borrower, you could also potentially save money in the long run if you can refinance at a significantly lower interest rate than exists on your current loan.

If you’re thinking about refinancing, make sure to shop around and compare offers from several different options before committing to a specific lender.

2. When Auto Loan Refinancing Is a Good Idea

Refinancing can save you a lot of money, but that doesn’t mean it’s always the right thing to do. You should generally consider refinancing for one of two reasons—this is a major financial decision, so it’s important to think carefully about the pros and cons of each option.

You Can’t Make Payments

The most obvious time to refinance your auto loan is when you’re having trouble making the payments you agreed to when you took out the original loan. High monthly payments can make your budget much more difficult to manage and cut into other areas of your life.

Paying more in interest is a small price to pay to avoid more serious obstacles like defaulting on a loan. Late and missed payments will also hurt your credit score and prevent you from accessing lines of credit later on, so you should refinance as soon as possible if you know you’re not going to be able to make payments.

You Found a Better Offer

Interest rates fluctuate constantly, so the best available offer when you purchased your car may not be as good as the one you could get now. Paying a lower interest rate will allow you to pay off your balance with less money and help you save more cash for other areas of your budget or even put together an emergency fund.

Even a slightly lower interest rate could save you hundreds or even thousands of dollars depending on the size and term of your loan, so you should always be looking at refinancing options to see if there’s a better offer. Car dealerships typically offer loans with higher interest rates compared to more conventional lenders.

3. When to Avoid Auto Loan Refinancing

These are two of the best signs that refinancing could be right for you, but there are also some situations in which you should stick to the original loan. These are a few of the most important drawbacks that lead people to pay off their balance rather than refinancing with a new loan.

You’ve Made Progress on the First Loan

Interest payments can be incredibly frustrating, and they often lead people to feel like they aren’t making progress on their loans. That said, you typically pay more interest over the first half of a loan than the second—as the balance decreases, less interest compounds each month.

If you’ve already paid off the majority of your original auto loan, you probably won’t save much money by refinancing, even if you’re able to find a loan with a lower interest rate. Refinancing earlier on gives you the opportunity to save more on interest while reducing your monthly payment and freeing up cash flow.

Your Auto Loan Carries Prepayment Penalties

You might assume that paying off a loan as quickly as possible is the best way to minimize interest, but many loans charge prepayment penalties designed to give lenders as much interest as possible. These fees remove the incentive to pay off your balance and make refinancing a less attractive option.

Other loans calculate all interest upfront and require you to pay the entire bill regardless of when you finish paying off the principal. Refinancing fees for things like re-registration and lien holding can also add to your costs, although they typically make up a small payment compared to how much you could save by refinancing.

Your Car Has Already Depreciated

Cars depreciate more quickly during the first few years of ownership than at any other time, so most lenders are reluctant to offer refinancing loans after this period. It’s generally easiest to refinance within the first three to five years of owning your car, although some lenders may be willing to work with you later.

4. The Importance of Credit

Interest rates fluctuate naturally based on market conditions, but your refinancing options are mainly determined by your credit report and your history as a borrower. People with a higher credit score have access to more loan offers and more options with competitive interest rates.

If you have a poor credit history, lenders see you as less reliable and will charge more in interest to compensate for the additional risk. Refinancing is a great option if your credit has significantly improved since you purchased the car, as you may be able to find a loan with a substantially lower interest rate.

With that in mind, you should do everything possible to maximize your credit score if you know you’ll need to consider refinancing options. Some of the easiest ways to improve your credit include making on-time payments, using less than 30 percent of your credit limit, and regularly checking your report to identify irregularities and inaccuracies.

Keep in mind that refinancing itself may hurt your credit score, although the impact shouldn’t be more than a few points. You should avoid refinancing and other types of credit if you know that you’ll be applying for a new line of credit in the near future. This is especially critical for mortgages, auto loans, and similar loans—the larger the balance, the more important it becomes to find the lowest possible interest rate.

5. How to Find the Right Auto Loan

If you’ve decided to refinance your auto loan, the next step is comparing your options and looking for a loan that meets your needs. You should start shopping around well before you need the money—the longer you wait, the less time you’ll have to look at offers and wait for the perfect opportunity.

The interest rate is the most obvious factor to consider when comparing loans, but there are a number of other important criteria that should affect your decision. A longer term, for example, gives you more time to pay off the loan and increases your cash flow by requiring smaller payments each month.

On the other hand, shorter terms give you the chance to pay off the balance more quickly and avoid more interest. You should look for a long-term loan if you need cash flow immediately, but short-term loans are better if you’re simply looking to save money relative to the original loan. Remember that everyone is in different circumstances—the right answer for you depends on your unique financial situation and goals.

Refinancing an auto loan for the first time can be confusing, and it’s often difficult to determine which strategy gives you the chance to save as much money as possible. With so much to consider, it’s easy to feel overwhelmed and simply stick to the original loan. These tips will help you identify the best refinancing options for you and pay off your debt as quickly as possible.

Logan Allec
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