The average price of a new non-luxury vehicle topped $44,000 in July 2022, according to Kelley Blue Book. That number is dwarfed by the average for a luxury full-size SUV, at over $100,000.
With these prices, buying a new or used car usually involves getting an auto loan. And it’s no surprise that a big car payment can have a major impact on your monthly budget. If money is tight and your credit is excellent, you might be considering refinancing your auto loan.
We’ll discuss the pros and cons of refinancing an auto loan, as well as some alternative financing options you might not be aware of.
What Is a Car Refinance?
Refinancing a car loan essentially means applying for a new loan to pay off the balance on your existing auto loan. The goal is usually a lower interest rate or lower monthly payments. Some people who are unable to lower their rate can attempt to extend their repayment term in order to secure lower monthly payments.
Refinancing a car doesn’t automatically mean a lower interest rate or lower monthly payments. The rate you’re offered depends on your credit score and the lender. But if your credit history and debt-to-income ratio have improved since you took out your car loan, refinancing can potentially save you money. (If you need a refresher on auto loan lingo, this guide to auto loan basics can help.)
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Pros of Refinancing a Car Loan
There are a number of situations when it might make sense to refinance a car loan.
1. Your credit score has improved since you took out your current loan, making it possible to qualify for a lower interest rate on a new loan. If your financial history hasn’t improved since you first got your car loan, or if your credit score has gone down, refinancing might not be for you.
2. You’re looking to lower your monthly payments, either with an interest-rate reduction or a longer loan term. How much can you save? If your current loan has a term of four years, or 48 months, and a monthly payment of $500, refinancing with a six-year term (60 months) can lower your payments to about $375 — enough to make refinancing worth it for many people.
3. You want to work with a new lender. Some lenders don’t have the best customer service. That can become a big issue if you have to make a claim. And if you financed your car through the dealership, or if your original lender sold your loan to a third party, you may be better off choosing your own lender and refinancing.
4. You want to become debt-free faster. If your income has increased or you’ve freed up more money in your budget, you might consider putting more toward your car loan. In that case, you can refinance with a shorter loan term. Your monthly payment will be higher, but you’ll get out of debt faster and own your car outright.
Recommended: Common Uses for Personal Loans
Cons of Refinancing a Car Loan
If you’re deciding whether refinancing is right for you, here are some important caveats:
1. Extending your loan term on its own doesn’t save you money. Extending the length of a car loan at the same rate will result in lower monthly payments but more interest paid over the life of the loan. For example, a $15,000 auto loan with an APR of 7.5% and five years (60 months) remaining will cost $18,034 in total. Extending that loan to a seven-year period (84 months) will cost $19,326 — a difference of $1,292.
2. You don’t qualify for a lower interest rate. Refinancing a car loan doesn’t always mean a lower interest rate. If your credit score went down since you took out the loan, you may only be eligible for a higher rate than your current car loan.
3. You have a balance under $5,000. Most lenders won’t refinance a car loan that has less than $5,000 remaining. For some lenders, the cutoff for refinancing is $7,500.
4. You have less than two years on your loan. Given the fees and hassle involved in refinancing, it will be very difficult to save money if you have less than 24 months left on your loan.
5. Your loan has prepayment penalties. Check your existing loan agreement for a “prepayment penalty” clause. If you find one, your current lender can charge you a fee for paying off your loan early — which might cancel out much of your savings.
Recommended: Types of Personal Loans
Alternatives to Car Refinancing
Balance-Transfer Credit Card
Many balance transfer credit cards don’t require interest payments for several months. This move is only worthwhile if the auto loan balance can be paid off during the interest-free time, which can range from six to 21 months.
Be aware that some major credit card issuers don’t allow balance transfers on a loan. And some balance transfers come with a fee of 3% to 5%, which can wipe out much or all of your interest savings.
A personal loan can be used for almost anything: unexpected medical expenses, home repairs, and yes, paying off an auto loan. Many personal loans are unsecured, meaning they’re not backed by collateral. That makes personal loan interest rates generally lower than credit cards but higher than auto loans.
Personal loan requirements vary by lender. Lenders look at your credit score to help determine your interest rate. The lower your score, the higher your rate. Borrowers also need to show proof of income and employment.
Lenders also look at your debt-to-income ratio (DTI). That’s the ratio of your gross monthly income compared to your monthly debt payments. Lenders prefer a DTI of 36% or lower.
If your car loan balance is over $5,000 and you’re able to get a lower interest rate or change the payback term, a personal loan can be worthwhile. A personal loan calculator can help you decide.
Although a car loan refinance isn’t for everyone, it may be a good choice for drivers looking to lower their interest rate or change the length of the loan. Some drivers extend their loan term to secure lower monthly payments, but this means they’ll pay more in interest over the life of the loan. Other drivers who want to get out of debt fast may want to shorten their loan term. This will save them money in interest but raise their monthly payments. In some circumstances, it might be worthwhile to pay off your auto loan with a balance-transfer credit card or a personal loan.
If a personal loan of $5,000 to $100,000 sounds like it could be a good fit, check out SoFi fixed-rate personal loans. They come with no fees required and with terms of up to seven years.
What are the advantages of refinancing your car?
There are a few advantages to refinancing a car loan, though they won’t all apply to every person’s situation. First, if your credit score has improved since you took out the loan, you may qualify for a lower interest rate — and that can save you significant money. Second, even if you don’t get a lower interest rate, refinancing can extend the payback period, lowering your monthly payments. (Just know that you’ll pay more in interest over the life of the loan.) Third, if your income has increased, you might actually want to refinance with a shorter payback term, which may save you money on interest and make you debt-free sooner.
When should you refinance a car loan?
We’re sorry to put it this way, but it depends. Technically, you can refinance a car loan at any time. But typically, you’ll want to wait until your credit score improves to take full advantage of the benefits of refinancing. That can take between six and 12 months. (Also, some lenders won’t consider your application until they’ve seen six to 12 months of your payment history.) On the flip side, you won’t save much money if you have less than two years left on the loan. That’s because lenders charge most of their interest up front.
How soon can you refinance your car loan after purchase?
Although some lenders won’t consider a refinance application until at least six months have passed, you can probably find someone to approve a refinancing as soon as your car rolls off the lot. On the other hand, it’s in the driver’s best interest to wait six to 12 months before refinancing. That way, your credit score has time to improve, qualifying you for a better interest rate — or at least not a lower rate.
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