When you borrow money to help you pay for a car in the form of an auto loan, you aren’t necessarily stuck with that same loan till you pay it off. Perhaps a better loan comes along that can help you save money and you want to switch to that loan, and refinancing makes sense.

Now you may be asking yourself: What is refinancing or what does it mean?

What is it?

In short, when you refinance a vehicle loan you are basically taking out a new loan to pay the remaining balance on your current loan. Refinancing a loan at the right time, and correctly, can lower your monthly payment and interest rate.

The goal of refinancing a loan is to pay less interest over the term of a loan, which will lead to more potential savings. There isn’t a minimum amount of time you have to wait before you can refinance a loan, you just have to make sure that you meet the requirements of the new loan you want to switch to.

You can even refinance before the first monthly payment of your original loan, just be sure that you end up with a better deal and the refinance doesn’t end up costing you more money.

As mentioned previously, the biggest advantage of refinancing a loan is that you may pay less interest or lower your monthly payment, saving you money throughout your loan term. Interest rates change all of the time, so there is a chance that rates have decreased since you started your original loan and a lower interest rate will most likely lead to a lower monthly payment.

However, just because a loan has a better interest rate doesn’t mean that you will save more money. In fact, you could end up paying more money. If you refinance to a loan with a lower interest rate, but longer loan term, you might end up paying more in the long run.

Because of this, when looking to refinance make sure you take your time deciding and do your research, such as utilizing a loan calculator to crunch the numbers, and make sure you will be paying less overall.

Also, refinancing to a loan with a longer term could put you in a position where your loan is “upside down” or, in other words, you owe more on your car than what it is worth. In order to get rid of the car you would have to write a check to a lender or keep making payments on a car you don’t use.

When to do it?

Your financial situation improved: Lenders tend to use things like your credit score to decide your auto loan rate. If you believe your credit score has improved, it may be a good time to drive toward refinancing your auto loan.

Your credit improves over time as you make on-time payments to your loan. As you make successful payments you will raise your credit score, opening up more loan options for you. If your credit score has increased you may be able to qualify for a better loan that you can refinance on and save money.

A drop in interest rates has occurred: As mentioned earlier, interest rates change regularly and there is a chance that rates have decreased since you signed off on your original auto loan. A rate decrease of as little as 0.5% to 1% is enough to earn you savings over the term of your loan.

You are struggling to keep up with monthly bills: If your monthly payments happen to be causing your wallet to look rough, it may be worth trying to find a loan with a longer term to reduce your monthly payment.

You may also be able to renegotiate the term of your current loan, but keep in mind that the longer the loan term the more time you will spend paying interest on it. You will generally pay more interest overall if you have a loan with a longer term.

When NOT to Refinance

While refinancing can save you money, it may not always be the right option for you. Use these situations as a set of guidelines on when not to refinance.

Fees Outweigh Benefits: A big thing when it comes to refinancing is to pay attention to the fees that may come with it. For example, there could be prepayment penalties for paying off your original loan earlier than planned with your refinanced loan. You might also have to pay additional interest with the principal.

There are some loans that come with aspects such as precomputed interest, that make you pay all of the interest in addition to the principal. So, be on the lookout for things like this in the fine print of your original loan contract.

Lastly, you will probably end up having refinance fees, which can include lien holder and state re-registration fees. These typically don’t cost more than $85 combined, but it is still a wise idea to make sure you can afford these types of fees before you refinance.

Most of your original loan is paid off: Often times interest is front-loaded, which means that you pay the majority of the interest in the beginning part of the loan term. This happens because the interest rate on your loan is applied to the current loan balance each month. So, as you pay down your loan balance the amount of interest you collect will also decrease.

Your car is kind of old or you have racked up the miles on it: Cars tend to depreciate. To give you an idea, some lenders will not refinance vehicles that are seven years or older or have more than 100,000 miles on them.

You want to apply for more credit in the future: Choosing to refinance a loan could have a negative impact on your credit. Because the refinance will show up as a new loan on your credit file and there will be a new inquiry to go along with it. Some mortgage lenders like to see no new credit while they are working on your mortgage application.

Refinancing

Refinancing is something that can save you money and help you out in the long run, but you want to be careful and only consider it when the right circumstances have come up.

As previously discussed, if interest rates have decreased, you found a better loan, or your financial situation has improved, it might be worth looking into refinancing with a better loan. Don’t wait too long though or the benefits of an auto loan refinance may not outweigh the fees and cons.

If you choose to refinance be sure to have your existing loan information, vehicle’s information such as the VIN, make, model, and year, and your proof of income.

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