It’s not uncommon for homeowners to refinance their home loans, but have you ever considered refinancing the loan on your car? It’s surprisingly common when economic conditions are right, and it’s far easier than the sometimes painful process of trying to refinance your mortgage.
Keep reading before you get too excited about saving some money with lower monthly payments. We’ve outlined some helpful hints for drivers trying to decide whether it would be a good or a bad idea to refinance a car loan.
When It’s a Good Idea to Refinance
Refinancing at a lower annual percentage rate (APR) will lower monthly payments, but most importantly, it will decrease the amount of interest you have to pay on the loan. There are several situations in which it may be beneficial to refinance your car loan.
One is if you’re trying to take advantage of lower interest rates. With the current average interest rate for a new car loan being about 7%, it’s unlikely that many buyers with good credit want to refinance right now. However, buyers who financed cars in 2023 with higher interest rates will be considering loan refinance options if or when the current rates fall.
While interest rates are generally higher today, it’s a good idea to consider if your credit situation has improved substantially compared to when you bought the car. If you’ve improved your credit enough, the interest rate your lender offers will likely go down, which means you’ll make a lower monthly payment. Plus, you’ll pay out less money in interest.
Another reason you to refinance is to get a shorter loan term. This scenario especially applies to drivers who have had significant changes in their financial situation. For instance, if you’ve earned a promotion at work or got a new job that pays better than before, you might consider refinancing your long-term car loan to a shorter term. Your payments will be higher, but you’ll pay the car off sooner, and you’ll pay less money over time in interest.
When It’s a Bad Idea to Refinance
There are also several situations where refinancing a car loan won’t benefit you.
If your existing loan includes a pre-payment penalty or other early termination fees, do some math beforehand. For instance, if you have a $500 pre-payment penalty, you should only refinance if doing so can save you at least $500 or more.
In general, you also shouldn’t refinance your car loan if you end up extending the loan’s term. For example, if you’re currently set to pay off your loan in 36 months, refinancing to 48 or 60 months is usually a bad idea. Such a change may seem tempting because it will lower your payments, but a longer loan term usually means you’ll pay out more money in interest.
The only exception to this rule is if you’re in grave danger of not making the monthly payments. In a case like that, refinancing over a longer term is better than defaulting on the loan.
MORE: Car Financing Glossary: Finance Terminology Explained
Should You Do It?
If you’ve decided to refinance your car loan, talk to your current lender as the next step. You may not have to shop around at all, as your bank might be willing to drop your interest rate or shorten your term. If not, start the shopping process by checking with various lenders, both online and in person.
Read Related Articles:
- Car Finance 101: Everything You Need to Know
- What’s the Catch with Zero Percent Financing Car Loans?
- Financing a Car: Are Taxes and Fees Included in Financing?
Editor’s Note: This article has been updated since its initial publication.
