Should I Refinance My Car Loan in 2025?

Should I Refinance My Car Loan?

The car finance industry is booming. The latest research shows that over 80 percent of new vehicles purchased in the United States, in the second quarter of 2020, were obtained through a car loan.

Have you taken out an auto loan to pay for your vehicle? How are you managing the payments? Could you benefit from better terms? Whether you have been struggling to pay your monthly payments or you have seen a lower rate of interest elsewhere, refinancing your car loan could save you money in the long run and make your monthly commitments more manageable.

What Does Refinancing a Car Loan Mean?

Car loans are typically paid off in fixed monthly repayments over a number of years and secured with the car as collateral. They present one of the easiest ways for Americans to afford a car today. The principle of refinancing a car loan is simple: you take on a new loan to pay off the balance of the old loan. For example, if your financial position has improved or interest rates have fallen since you took out the original loan you may wish to consider refinancing.

Why Refinance a Car Loan?

Most people refinance an auto loan to save money. Refinancing a loan could net you a lower interest rate and lower monthly payments. This can be a sensible way to free up cash for other financial obligations.

Even if you don't manage to secure a more favorable interest rate, you might be able to find a loan that has a longer repayment period. This is another way you can lower your monthly payments. Let's take a closer look at the reasons why you might want to refinance your car.

• A Drop in the Interest Rate. Interest rates can fluctuate greatly and unpredictably. If rates have taken a tumble since you took out your original loan, it might be prudent to refinance. Even a small dip in percentage points could give you some significant savings over the life of the loan.
  Example: Bob takes out a $20,000 auto loan with an interest rate of 6% over a 60-month period. His monthly repayments are $387 and he'll pay a total of $3,196 over the lifetime of the loan. Two years later, interest rates drop to 3.5%. Bob decides to refinance his loan. Thanks to his forward-thinking, Bob will now pay $364 a month and a total of $1,839 in interest over the lifetime of the loan.
• You Want Lower Monthly Repayments. If you're finding it hard to meet your monthly obligations, don't risk damaging your credit score. Refinancing over a longer term or with a lower interest rate could help to minimize your monthly payments and the risk of you going into the red each month. We can see this easily using Bob's example above. By refinancing a loan with a lower interest rate, he was able to save $23 a month. It's important to keep in mind, however, that while a loan with lower repayments will help you in the short term, you could be putting yourself at more financial risk by extending the terms. You could be stuck repaying the loan long after the value of your vehicle has depreciated. In a nutshell, refinancing a car loan can make good financial sense if you want to save money or give yourself some breathing space each month with lower monthly payments. If you do increase the length of your loan to reduce your monthly outgoings, you might want to consider decreasing it again if your financial position improves.
• You Took Out Your Original Loan Through a Dealership. Dealerships make a lot of money on auto loans. That is because the interest rate on a dealership auto loan is often higher than other car loans in the market. Dealership loans are often attractive to customers because they allow them to get loan approval and drive away their new car on the same day. However, in their excitement to own a new set of wheels, they can often overlook the less favorable interest rate on their loan. Fortunately, refinancing a dealership car loan could save you thousands of dollars over the lifetime of the loan. If you're shopping around for a better deal, there are many discounted rates available. Whether you have many years or a couple of years left on your auto loan, refinancing could be the best option.

When is the Right Time to Refinance?

The most important thing to consider when refinancing a car loan is whether it is the right time to do so. For example, your credit score will be a deciding factor in whether you can get a better deal. If your credit score has increased since you bought the car and you have been on time with your monthly payments, you are more likely to get a better rate of interest.

When Your Credit Score Has Improved

When making a lending decision, lenders often use FICO Auto Scores to determine your creditworthiness. A better credit score is a signal to lenders that you will be more likely to keep up with your payments and they will be more willing to give you a lower rate. If you are not sure what your credit score is right now, it's a good idea to check before applying for refinancing.

When Your Car is Worth More Than Your Remaining Loan

In most situations, it will be easier for a lender to agree to a new loan if your car is worth more than the remaining balance on your existing loan.

It might surprise you to learn that new cars can lose 20% of their original value in their first year. Some lenders won't lend you money against an older car and so it's worth checking their terms before making an application. However, if your car is still quite new and has plenty of equity, it could be a great time to refinance your car loan.

When Not to Refinance Your Car Loan

Refinancing a car could save you money but isn't the right move for some people. If any of the situations below apply to you, you might want to hold off and see your loan through to the end of its natural lifetime.

• Your Original Loan is Almost Paid Off. This might seem like a no-brainer but many people try to refinance a loan that they have almost paid off. The problem is that with many loans, the interest is often front-loaded which means you'll pay more interest at the start of the loan. It's still worth checking if you'll be better off by refinancing but, in most cases, it's a better idea to stick with the original loan.
• Your Car Isn't Worth the Risk to Lenders. Cars depreciate faster than many people realize. If you want to refinance, you may need to do so within the first few years of your cars life. It's not unusual for lenders to turn down loans for cars as young as seven years old.
• When Penalty Fees Outweigh the Benefits. It's not unusual for lenders to charge you an early pay off fee when settling a loan and refinancing with another lender or product. That's why it's important to understand the fees involved and calculate whether they outweigh the benefits of refinancing. The last thing you want is a loan that ends up costing you more than the original deal.
• The Impact on Your Credit Score. When you apply to refinance your car loan, it's important to know the impact on your credit score. When a lender checks your credit file for a loan application, this is known as a hard check. These hard checks will show up on your report and could knock a few points off your score. When shopping around for car loan refinancing, don't make multiple applications in the hope you'll be accepted by at least one lender. Instead, use a car loan comparison website to see what your options are. If you have bad credit, look for specific lenders that are more likely to approve people with a low score.

Final Word

Refinancing a car loan can make a lot of sense to many people. Whether interest rates have decreased, your financial position has changed or you've found a loan with better terms, you could find that refinancing is the right move for you. Shop around for refinancing offers and make sure you understand the terms, the payments, and the interest rate before committing.