For some people, refinancing their auto loans makes a lot of sense. But, what exactly does refinancing mean? Refinancing your auto loan is when you replace your existing loan with a new loan from a different lender. When this happens, your current lender pays off your old loan and you begin making monthly payments to your new lender instead. Ideally, your new payments are lower than your old ones.
If you’re wondering whether or not it makes sense to refinance your loan, we’ll explore some hypothetical scenarios below. In some cases, refinancing can lead to lower interest rates and lower monthly payments.
Should You Refinance Your Auto Loan?
If you’re looking for a way to lower your interest rate or your monthly payments, refinancing may be the right option for you. Let’s look at a hypothetical example. Imagine you’re paying a 10% interest rate on your current auto loan. If you’ve been making monthly payments on this loan for over a year, your credit score may have improved since you applied for that loan. If so, you may qualify for a lower interest rate. You are locked into the agreed-upon rate with your current lender, but there are other lenders out there who are looking for borrowers and who may extend a more favorable offer.
Let’s say your credit score did improve. You can go to another lender – whether it’s another bank, online lender, or credit union — and see if you qualify to refinance at a lower rate. If you do, you can refinance your car loan so your monthly payments are lower, enabling you to put more money into savings or use the money you save for other purposes.
Let’s look at a few more pros and cons of refinancing your auto loan.
Reduce Your Interest Rate
The main reason people consider refinancing their auto loans is to reduce their interest rates. This is especially true for people who had no or bad credit when applying for the original auto loan. There is nothing to lose by seeking out better offers after you’ve had a chance to improve your credit score. The benefits of paying a lower interest rate are that you can pay off your loan faster or lower your monthly payments. The bottom line is that you end up paying less over the life of the loan.
Lower Your Monthly Payment
Life happens, and sometimes it makes sense to reevaluate your budget and the outflow of money. Whether you just got married, bought a house, had a baby, or experienced some other major event that made money tight, it can help to find a way to reduce monthly expenses. Refinancing sometimes offers the opportunity to extend the life of the loan, which ultimately lowers your monthly payments. This can give you some financial breathing room to adapt. It’s important to remember that if you do extend the duration of the loan, you will likely pay more in interest over the life of the loan.
Improve Your Cash Flow
Even if you haven’t recently experienced a major life change that requires you to tighten your belt, it’s always nice to have extra cash on hand. If you currently owe less than what your vehicle is worth, refinancing may allow you to access more cash. For example, if you own a vehicle that is currently worth $10,000 and you still owe $6,000 on your auto loan, you may be able to refinance your vehicle for $8,000, making $2,000 available to you. How? By refinancing, your new lender will pay off the $6,000 you still owe. Your new loan for $8,000 is still below what your car is worth and you will have the leftover $2,000 available for any projects or other cash needs you may have. Just remember that a car is a depreciating asset that can lose value at a higher rate than other assets.
Refinancing an auto loan is not all rainbows and roses. Even if you refinance at a lower interest rate, if you extend the loan, you can pay more over the total duration of the loan. Be sure you run the numbers so you know that you are saving money or achieving what you hope to with refinancing. Getting a lower monthly rate is different than paying less overall in some circumstances, so pay attention to the fine print.
How to Refinance Your Auto Loan?
If you’ve evaluated the pros and the cons of your unique financial situation and have decided that refinancing your auto loan is best for you, there are a few things to do to get started.
1. Get organized
Your new lender will require certain information from you, so it’s best to have that documentation ready and organized. Be sure to have the following information and documents at hand before trying to apply for refinancing:
- Monthly repayment amount on your current auto loan
- Loan term of your current loan
- The interest rate of your current loan
- Original loan contract (you can often get this through the customer service department at your lender)
- Driver’s license
- Vehicle identification number (VIN) of your vehicle
- Proof of income (W2s and/or pay stubs from your current employer)
- Social security number
2. Evaluate your credit
If you’re looking for a lower interest rate, you’ll want to be sure your credit score is in good shape. If you’ve been on time with all of your payments for the last year or longer, you have probably added a few points to your credit score. Be sure to pull your credit report before applying to refinance your auto loan so you have a complete picture of what you’re working with and to identify any issues early on.
You made it! It’s finally time to apply for refinancing on your auto loan. It makes sense to apply to several different lenders so you can compare rates and find the most favorable offer. One trick to remember is to apply to different lenders within a 45-day span. These inquiries are more likely to get grouped and are viewed as one inquiry, which can lessen any impact on your credit score.
If refinancing your auto loan seems like a beneficial option to you, just be sure to do your homework and run the numbers on an auto loan calculator. Having an understanding of your total financial situation can help you make the best decision and maintain your financial well-being.