Nobody likes paying for their car loans. Especially since the average monthly payment on a new car loan is over $500. That’s a lot of cash you have to shell out each month, limiting what you can do with your money.
But the bigger problem is buying a car when interest rates are high. If you do, you could be throwing away even more money each month, thousands over the life of your loan.
If you have a high-interest rate on your auto loan, you should consider refinancing it. While there are plenty of pros and cons of refinancing a car loan, it’s definitely an option to consider if you’d like to lower your interest rate and your monthly payment.
So how does refinancing a car loan work? And what should you know before you refinance a car loan immediately? Keep reading to find out now.
What Does It Mean to Refinance a Car Loan?
Refinancing a car loan is similar to refinancing a mortgage. You basically get a new loan to replace your old loan and start making payments on the new loan right away. You can do this either by refinancing with a new lender or working with your existing lender.
If you have a lot of car equity, that means you’ve paid off a good amount of the loan so far. This equity can work to your advantage when refinancing, as it could mean lower monthly payments, a better interest rate, or an adjusted payoff term.
How Does Refinancing a Car Work?
The process of refinancing a car is quite simple. First, you’ll contact multiple lenders, inquiring about the car refinance process. You’ll let them know what your goal is for refinancing, as that will determine what type of quote they come up with.
After the standard application and credit check, they’ll provide you with a quote based on your current loan and your financial situation. You can compare car refinance rates across multiple lenders to ensure you are choosing the company offering the best deal.
Once the refinance is approved, the new lender will then pay off the old loan in full, and set up a new loan for you to begin making payments on.
When it comes to your credit report, the old loan will still show up on your report, but it will show that it’s been paid off. The new loan will appear. You may notice an immediate dip in your score with all the activity in a short amount of time, but your score should normalize soon after.
Pros and Cons of Refinancing a Car Loan
So why would you want to refinance a car? There are a number of reasons that it appeals to borrowers. Here are the pros of refinancing a car loan.
Lower Interest Rate
A lot of people refinance a car loan because interest rates have dropped since they bought their car. For example, if the going rate was 7% when you got the car, but a year later the rate is only 4%, then it could be worth refinancing.
A significantly lower rate could save you hundreds, if not thousands, of dollars over the life of your loan.
Lower Monthly Payments
The other most common reason people refinance their auto loans is to lower their monthly payments. Car loans are generally the highest payment most individuals make each month, after their mortgage or rent.
If you are in a tight spot and need to free up cash, you could refinance, setting the new loan limit on the car’s current value as opposed to its initial value.
Greater Monthly Cash Flow
With lower monthly payments comes increased cash flow. This may be necessary for your daily expenses if you ever take a pay cut or lose a job.
Or, if you’d simply like to save money for other expenses, such as a new home, remodeling project, or vacation, the extra cash can go a long way.
Many people need to get an auto loan with the help of a co-signer. This might be due to the borrower having a new job without a sufficient work history.
After a couple of years, they could refinance to remove co-signers. That way, the co-signer no longer has the loan tied to their name, and they can get loans of their own without unnecessary limitations.
Cons of Refinancing
Regardless of your reason to refinance, it will always have some consequences. Understand these before even getting refinance quotes.
Longer Payoff Time
Oftentimes when refinancing an auto loan, it means your new loan is going to last longer than the original one was set to last. So even if you have lower monthly payments, you’ll be paying the loan for years longer.
While sometimes it’s necessary to free up cash now, always consider the long-term impact of your decisions.
Possibly Paying More Interest Over Time
Because refinancing often means a longer payback time, it also might mean you pay more over the life of your loan.
With those lower monthly payments or even a lower interest rate, the fact that you have to make payments for a few extra years might mean paying hundreds, if not thousands of extra dollars on interest.
Credit Score Impact
Any time that you pay off an existing balance, apply for a new loan, or get a new loan, your credit score will change. Typically, it will drop, though usually, the drop isn’t permanent.
But the additional loan on your credit report could mean that you have a difficult time getting another new loan in the future. So if you planning on buying a home, it’s best not to refinance a car loan within six months or longer.
Determine What’s Right for You
Now that you understand the pros and cons of refinancing a car loan, it’s time to decide what makes sense for you. If freeing up cash now will drastically improve the quality of your life, and you understand the long-term implications, it may be worth refinancing.
Just be sure to always think and plan ahead before making big decisions like this. Looking for more helpful articles? Check out our blog today to find other content like this.