Refinancing a Car: What Are the Pros and Cons?
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The benefits when you refinance a car loan can include lowering your monthly car payment, reducing the interest you pay or shortening your loan term.
The downsides to auto loan refinancing can include paying lender fees and additional interest if you extend the loan term or cash out auto equity. You could also end up owing more than your car is worth.
As you decide whether refinancing your car loan is worth the time, effort or savings, here are some pros and cons to consider.
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Pros of refinancing your car loan
You could pay less in interest
If you had poor or no credit when you bought your car and your credit has since improved, you could qualify for a lower interest rate. This is especially true if you have consistently made on-time payments for six to 12 months. Also, you might have accepted a higher rate at a dealership than you could have qualified for elsewhere, and you now want to reduce that rate through refinancing.
Whatever the situation, if you can lower your current loan rate by 1% or more, you could save enough in interest over the life of the loan to make refinancing worthwhile.
You may lower your monthly payment
Refinancing can reduce a monthly car payment that’s too large for your budget. A lower payment can free up funds to pay off other, higher-rate debt. It can also help you through times of financial difficulty, like a sudden drop in income.
Refinancing to a lower interest rate will decrease your monthly car payment some, but to significantly reduce your payment, you might have to extend your loan term. Going with a longer term can be a negative since you’ll most likely pay more interest over the life of the loan. On the other hand, it can be a positive if it prevents you from falling behind on payments.
You might be able to pay your loan off earlier
If you’ve had an increase in income since buying your car, you could consider refinancing your car loan to a shorter term and lower interest rate to pay it off sooner. Of course, you could go the route of paying extra on your current car payment, but refinancing could help direct more of those dollars to principal, saving even more.
You could possibly tap the equity in your car
If you need cash, you may be able to borrow with a cash-out auto refinance loan using your car’s equity (the value of your car minus the amount you owe on it). So if your car is worth $20,000 and you have $10,000 remaining to pay on your loan, you could get a refinance loan for $15,000 and take $5,000 in cash. There are limits and some downsides associated with cash-out refinancing, so you might go this route only for financial emergencies or if you have a strategic plan for using the money to pay off higher-rate debt.
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Cons of refinancing your car loan
You could pay more in interest
If you refinance to a longer loan term to reduce your payment, you may actually pay more overall because of the additional months of interest you pay. Even a reduced rate may not offset the cost of continuing to pay interest for an extra year or two.
You might have to pay fees
Your state may charge fees to re-register your car or transfer the title. And your refinance lender could have application or origination fees. Your current lender might also charge a prepayment penalty for paying your loan off early, although prepayment fees aren't as common as they used to be. Compare your total in fees with the amount you will save from refinancing.
You could wind up upside down
Refinancing to extend your term or taking cash out of your equity could leave you owing more than what your car is worth, referred to as being upside-down on your loan. If you decide to sell or trade in your car, you would have to pay the lender the difference, which could amount to thousands of dollars.
Should I refinance my car?
Knowing the advantages and possible disadvantages of auto refinancing is helpful, but a few additional steps can help you evaluate if refinancing is a good idea for you:
Have a clear goal. Do you want to lower your monthly payment, get cash for an emergency or pay your loan off sooner? Knowing what you want to accomplish can help you when evaluating loan offers and running numbers.
Get refinance loan offers. Shop auto refinance loans and rates with several lenders to see what rate you'll qualify for with various terms. Many lenders offer pre-qualification, so you can get rate estimates without affecting your credit scores.
Run the numbers. Use our auto loan refinance calculator to compare your current auto loan with refinance loan possibilities and see how it will affect your monthly payment. You can also see how much refinancing will cost or save you in total, including interest.
It’s always a good idea to weigh the pros and cons before you rush into refinancing a car. Even if your goal is simply to use your car’s equity for emergency cash, you should read the fine print and know the overall cost you're committing to.
