As of March 2019, Americans owed an estimated $1.16 trillion in auto loans, which amounts to nearly 10% of all outstanding consumer debt in the U.S. And on top of mounting auto debt, the Federal Reserve reported that approximately 7 million Americans were behind on their auto loans by 90 days or more at the end of 2018.
Now, it’s no secret that struggling with debt can make you feel like you’re drowning in waves of negative dollars, but there are certainly ways to improve your relationship with debt. Considering your financial options, such as refinancing an auto loan, can help you take hold of your debt and work your way toward a better financial future. But before refinancing your car, you should ask yourself, “should I refinance my car?”, and take a deeper look at what refinancing really means, what the pros and cons are, and when it makes sense to refinance an auto loan. In this article, we’ll discuss these points and more to help you decide if refinancing your auto loan is a sensible option for you.
To find quick information that answers the question “should I refinance my car?” use the links below to jump ahead. Or, read our complete guide to get all of the details you need to make the most informed financial decision for your situation.
- What Does Refinancing a Car Mean?
- 3 Reasons it Might Make Sense to Refinance Your Car
- Takeaways: When Should I Refinance my Car?
What Does Refinancing a Car Mean?
According to Investopedia’s definition of refinancing, a refinance is when a lender agrees to offer a new loan to a consumer with terms that would ideally work in the consumer’s favor, whether it’s a reduced interest, lower monthly payments, or some other benefit as a result. Refinances typically happen when there’s been a change in the interest rate market, or when a consumer’s improved credit qualifies them for more favorable loan terms.
There are many potential risks and benefits to refinancing a car loan, which we’ll discuss a little later on.
How does refinancing a car work?
In order to get a refinanced auto loan, mortgage, or student loan, lenders will reevaluate the consumer’s credit score and status before approving a new loan. If the lender determines that the results of their credit report makes them eligible for new loan terms, the lender will then propose a revised loan agreement with which the borrower can pay off their previous loan and adopt their new loan payment terms.
You can refinance a loan with your current lender, or with a different financial institution, like a bank or credit union, depending on your loan terms and what makes the most sense for your situation. Consumers should keep in mind that the refinancing process varies from lender to lender.
Before you choose to refinance your car, though, consider the advantages and disadvantages of making this kind of financial decision. Let’s take a look at some of these considerations.
Benefits and Risks of Refinancing a Car
The way in which a refinanced car loan impacts you depends entirely on your unique situation—be sure to keep your finances and lifestyle in mind as you read through the potential risks and benefits of refinancing an auto loan.
Benefits of refinancing an auto loan:
- Save money on interest
- One common reason consumers choose to refinance any type of loan is to take advantage of lower interest rates. If your credit score has improved, or if federal interest rates have gone down, you may be able to find a loan that charges less interest. In turn, this saves you money and should hopefully enable you to pay off your loan faster.
- Consolidate debt
- Another advantage some consumers experience when they refinance a loan is the ability to consolidate their debt. Debt consolidation basically means that instead of having many monthly loan payments, you’d only have one payment to worry about. For some, this simplified structure makes it easier to make monthly payments and maintain financial stability.
- Shorter loan terms
- If you want to get out of debt faster, you may consider refinancing so that you can pay off your loan ASAP. Depending on the kind of loan agreement you have, you might be able to make extra payments to chip away at your debt without refinancing, but be sure to confirm that there aren’t any early repayment penalties.
- Different loan type
- When you initially applied for your loan, your lender likely discussed the differences between fixed-rate and variable rate loans. In a variable loan, your interest rate can fluctuate, whereas, in a fixed-rate loan, your interest rate remains consistent throughout the loan term.
- More manageable monthly payments
- If you find that you’re struggling to make your monthly auto loan payments, refinancing may help you lower your monthly balances. Keep in mind, when you lower your monthly payment, the duration of your loan becomes longer as a result.
Risks of refinancing an auto loan:
- Associated costs
- Before deciding to refinance your auto loan, consumers should evaluate the costs associated with the process. The average lender fee for a refinanced vehicle is $10, while the title fee is typically $75 or less, but the rates may vary by lender and loan type. If the total cost of the refinance is more than your savings on the new loan, it might not make sense to go through with that particular loan agreement.
- Increased interest
Ultimately, the goal of refinancing a car is to get a better deal on your loan agreement, but sometimes it can end up costing you more if your loan is extended. Think about it: the longer you have to make monthly payments on your loan, the more interest you’ll pay. In addition to considering the costs of refinancing, consumers should also pay attention to the actual savings they’ll get with their new loan terms.
Now that you’re aware of the potential risks and benefits associated with refinancing a vehicle loan, let’s take a look at a few different scenarios when it could make sense to refinance your car.
3 Reasons it Could Make Sense to Refinance Your Car
1) If you need more manageable monthly payments
According to data from Edmunds, the average new car monthly payment in 2018 reached a record-high of $531. Depending on your debt-to-income ratio, this kind of bill could seriously damage your finances if you’re unable to afford such high rates month after month.
With a refinanced loan, you could potentially extend the lifetime of your loan, but it’s worth noting that a longer loan term most often means more money paid since interest rates compound over time. However, defaulting on a loan as a result of missed payments could result in much more serious consequences. If a loan defaults, lenders may take aggressive debt collections, which could include the repossession of your vehicle in order to settle loan debt.
2) If you’re able to secure a better interest rate
Paying too much interest can quickly accelerate your loan balance and end up throwing you into a cycle of revolving debt. Refinancing your car is one method consumers may consider to help minimize the amount of interest paid on auto loans.
There are two main reasons you may be able to get a better interest rate upon refinancing your car loan:
- Federal interest rates are decreasing
- A positive change to your financial wellness qualifies you for a lower interest rate (more on this in a moment)
If the Federal Reserve decides to lower interest rates, this could mean that your lender may be able to decrease their loan rates in alignment with the trend. If this occurs, you could benefit from refinancing your auto loan.
If you do get approved for a lower interest rate than the one you currently have, be sure to check that the savings you get on interest are greater than the cost of refinancing your loan.
3) If you qualify for a more favorable loan agreement
Another reason consumers choose to refinance is when their financial well-being has improved since they initially applied for the loan. A jump in credit score, for example, could qualify you for lower interest rates or more favorable loan terms with a refinanced loan.
According to TransUnion’s VantageSore system, here is how credit scores are graded on an A-F scale:
|Credit Score Grade||VantageScore® 3.0 Score Range|
Takeaways: When Should I Refinance My Car?
Let’s review some common questions about refinancing a vehicle so that you can make the most informed decision possible when evaluating your auto loan options.
- What happens when you refinance a car? When you refinance a vehicle, you apply for a new loan with more favorable terms.
- Is it bad to refinance a car? Refinancing a car loan isn’t a bad thing, but it could have adverse effects on your finances if you choose to refinance when it doesn’t make sense for you to do so. Some scenarios when refinancing may run the risk of becoming a debt mistake include:
- You’re upside-down on the loan—you owe more money than the car’s worth
- You’re close to paying off the original loan
- Your vehicle’s value has significantly depreciate
- Should I refinance my car? It depends. In order to decide if refinancing is worth pursuing, you should consider how the potential pros and cons would impact your financial profile. To see where your financial health stands, use Turbo. Our platform combines your credit score, loan details, and other relevant aspects of your financial history to help you make sound financial decisions and improve your relationship with money management.