When To Refinance Your Car Loan (And When Not To)

Now is a great time to buy a car. Interest rates are low, making monthly payments more affordable. If you financed a car with a higher interest rate, you are just out of luck. Or are you?

When To Refinance Your Car Loan (And When Not To)

When To Refinance

If you have an existing car loan, you may want to consider refinancing with a new loan. In some situations, this can help you save money and lower your monthly payments. When you refinance, you take out a new loan with a lower interest rate to pay off your existing loan.

You then owe payments based on the terms of your new, refinanced loan. Maybe your credit is better now than when you took out your loan. Maybe the interest rates across the board have gone down since you took out your loan. Either way, you may be able to get a better interest rate if you refinance, which means less money you pay in interest.

There are cases where refinancing will actually raise your monthly payments.

What, why on Earth would you want to do that? You’ll find out in next.

Increasing your monthly loan payments happens when you as the borrower agree to specific terms to do so.

If you earn a promotion at work, start a side business that takes off, or have additional income coming in for some other reason, you may want to pay off your car sooner.

Paying off your car sooner means you’ll pay less interest over the term of the loan, which means more money in your pocket.

Refinancing to change the terms of your loan, such as making it shorter with higher monthly payments, can accomplish this.

How Car Loans Calculate Interest

Car loans, like most loans, front-load the interest portion of the loan. For the first payments, the bulk of your money goes to the total interest that the bank expects you to pay, assuming you make every monthly payment for the life of the loan. A smaller portion of your payment goes towards principal, the amount that you actually borrowed from the bank to buy your car.

If you are in this stage of the loan, refinancing to get a lower interest rate will cut down on those interest amounts, thereby lowering your monthly payment and the amount of money that you actually pay to the bank over the long-term.

When Not To Refinance

However, there are situations where refinancing is not the best option. If you are towards the end of your loan, you may be better off just making additional payments rather than going through the paperwork, potential fees of refinancing and front-loaded interest on the next loan.

Because auto loans have the bulk of the interest payments made during the first part of the loan, you may not be saving very much by getting a lower rate towards the end of the life of your loan. A refinanced loan might be hard to get. Banks want to know that the value of the item they are loaning you money for is actually worth it. Older cars or cars that have depreciated significantly since they were first purchased may not be good candidates for a refinance in the bank’s eyes.

What Affects My Interest Rate?

The interest rate of your car loan will depend on your credit score. If you have a credit score of above 700, you should be getting a competitive rate for your car loan. Keep in mind that each credit reporting agency looks at slightly different things, so your score can vary slightly. A reputable lender will be able to explain what they are considering when looking at your credit report and the actual three-digit number, your credit score, that they are using to determine your rate.

The main thing to consider when looking at refinancing is how much money you are actually saving over the life of the loan. Interest is the most significant contributor and the place where you can save the most money by refinancing. If you keep the terms of the loan the same, paying less over the life of the loan will also lower your monthly payments, freeing up money monthly to put towards other priorities. If you are at the end of your loan or have a car that is no longer as valuable as when you purchased it, think hard and do your research before you agree to a refinance. Either way, your focus should be on keeping more money in your own pocket to reach your individual financial goals.

Have you successfully (or unsuccessfully) tried to refinance a car loan or any other loan recently? Tell us about your experience in the comments below!

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