The Pros and Cons of Refinancing a Car Loan

You’ve likely seen a lot of commercials promising homeowners that they can save hundreds of dollars a month on their mortgage if they just refinance. They get a huge chunk of money back, save money every month and pay off their homes faster.

You may wonder if you can do the same thing with your car loan, which is likely the second biggest investment you have made (or the biggest if you don’t own your home).

The answer is: you can refinance your loan.

However, whether or not you should is another matter. Learning everything you can about the process and then carefully evaluating your financial situation can help you make the best choice for your particular circumstances.

Here are a few pros and cons of refinancing a car loan for you to consider:

Pros

You could lower your interest rate.

If you bought your car several years ago when the economy was bad or you bought your car when you had less-than-stellar credit, you are probably paying a huge interest rate on your car loan. Refinancing your car loan might be a good idea if you have significantly improved your credit or if overall interest rates have improved considerably since you first took out the loan.

You need to be poised to reap a significant reduction in interest to make refinancing your loan worth it. A point or two will not be enough to save you much in the long run — and it could even cost you depending on the other terms of the loan.

You could get cash back.

If you have been paying on your car for some time or you have been paying ahead, you may have some good equity built into your car. Therefore, when you refinance your loan, you could end up getting some of that money back. The new loan will be offered for the value of the car, so if the car is worth more than what you owe on your current loan, you’ll get a nice cash payout.

Of course, you could put this money right back into paying off the loan, but you could also use it for a family vacation or some other nice purchase.

You could shorten the term of your loan.

Refinancing a car loan doesn’t have to save you money every month in order to save you money in the long run. If you refinance your loan for a shorter term, you’ll pay more each month, but you’ll pay off the car much faster. That means that you will pay much less in interest over the life of the loan, ultimately saving you hundreds or thousands of dollars.

You’ll only want to choose this option if you have the extra money to spend each month, such as if you’ve been promoted at work or have moved to a new company that offers a higher salary.

Cons

You’ll pay more in the long term.

While refinancing your car loan may lower your monthly payment slightly, it could end up costing you much more in the long term. The reason is that cars usually depreciate rather than gain value. In fact, Consumer Reports says that most cars depreciate an average of 45 percent in the first three years. That means that you likely owe more on your car loan than your car is worth at any given time.

When you refinance, you may be including negative equity in your new loan. That means that you’ll be starting the amortization process all over, paying mostly interest on your loan and widening the gap between what you owe and what the car is worth as it continues to depreciate but you don’t touch the principal. You’ll end up spending thousands more for your car over the life of the loan.

Of course, that is only if you even get approved for the refinance. If you have negative equity on your car, you will find it very hard to be approved for a loan refinance.

You may have to make a cash payment.

If you owe more on your loan than what your car is worth (and you probably do), you may be asked to make an upfront cash payment to cover the gap between the value of your car and the value of your loan. That usually defeats the purpose of refinancing the loan for most people, who are trying to put more money in their pockets instead of taking it out.

You may not save much each month.

If you want to see a big drop in your monthly payments, you will likely have to extend the life of your loan. Unless you get an interest rate that is markedly lower, your monthly payments will likely not change by much. The only way to make the dramatic difference you want is to take on a higher number of payments, which will increase the interest you pay and the overall amount you pay for your car.

When it comes to refinancing your car loan, there are tried-and-true rules to follow. However, some of the jargon can be confusing. In this update, we’ll be breaking down a few key concepts that you’ll need to know before moving forward. As always, if you have any questions, contact us and talk to our experienced finance department for the answers that you need.

Most consumers don’t realize that vehicles are eligible for refinancing, much like homes. In fact, major banks and financial institutions have solid vehicle refinancing programs designed to help buyers find more economical ways to pay off their cars. Deciding to refinance is usually triggered by a major life event, either negative or positive, such as a sharp reduction in your income or a significant credit score boost. Whatever the reason, if you’re looking into an auto refinance, it’s important to know all the facts.

Buying a car is one of the most significant financial investments we’ll make. And because we all need reliable transportation, it’s all but inevitable that we’ll have to buy a car at some point. Sometimes our circumstances don’t allow us to receive the best available interest rates at the time of purchase, but we commit anyway because our need for a car outweighs the penalties associated with low credit scores or not having a substantial down payment.

In cases like these, it’s not unusual to find yourself in different circumstances a year or more down the road. That’s when refinancing starts to make sense. Done correctly, it can relieve you of high interest rates, lower your monthly payments, shorten the length of your loan, or even all three.

If you’re considering refinancing your auto loan, we recommend familiarizing yourself with the following key components of vehicle financing before moving forward. Whether you have negative equity in your car or if your financial circumstances have changed for the better, refinancing might make sense for you.

What is Negative Equity?

Ultimately, we may find ourselves with a much higher monthly car payment or a longer car loan term than we had hoped for, which can sometimes result in what’s called negative equity. Negative equity means that we owe more than the vehicle is worth, and this is an extremely unfavorable situation for consumers, especially if the vehicle is unlikely to last mechanically until the end of the loan term.

Car owners can find themselves with negative equity when they purchased a vehicle at a premium price and, due to bad credit, were forced to accept an extremely high interest rate. These rates, sometimes referred to as subprime rates, can run as high as 20 percent and cost you a bundle in extra interest charges.

Unfortunately, over the loan term, it’s likely that your vehicle’s value won’t keep up with what you owe, resulting in a negative equity situation. When it comes time to sell or trade your car, you’ll need to pay the difference between what it’s worth and what you owe or risk rolling that extra cost into a new loan and starting the negative equity process all over again. In some negative equity circumstances, a refinance might make sense.

Tips for Refinancing

The best refinancing scenarios are the ones that benefit both the lender and the borrower. Your goals are likely to be lowering your payment, shortening the length of your loan, qualifying for a lower interest rate, or some combination of these. This is especially true when your credit score increases. Maybe your original loan happened at a time when you needed a car but could only qualify for a double-digit interest rate. In this case, taking a closer look at your existing loan documents to understand the loan terms is very beneficial.

A common mistake consumers make when contemplating automobile refinancing is neglecting to contact their existing lender. Borrowers assume refinancing must involve finding a different source for the loan. In fact, your current lender probably wants to hang on to your business. They know you, they know your vehicle, and they understand all the factors associated with your loan. If you’ve paid on time, and they want to retain your business, they may have a favorable solution.

Be sure you’re not relying on the lender to manage the process on your behalf. Take charge of your refinancing by reaching out to multiple lenders and understanding what it’s going to take to get out of your current loan. Read your loan documents thoroughly. Is there a prepayment penalty? Also, visit a site like Kelley Blue Book (kbb.com) to get an idea of your car’s market value. Compare it against what you owe on the loan. If you owe more than the car is worth, you have what’s called negative equity. If you roll that difference into a new loan, you’ll find yourself upside down. It might be better to pay down the existing loan until what you owe is equal to what the car is worth before seeking a new loan.

Here’s a summary of what you should do if you’re considering refinancing your auto loan:

• Determine your goals (lower payment, shorter loan term, lower interest rate)
• Find out if there is a prepayment penalty for getting out of your current loan and get your loan payoff amount
• Get your credit score and review your credit report to make sure there are no errors that might be contributing to a lower score
• Find out what your vehicle is worth – is it worth more or less than what you owe?
• Check your budget to determine how much you can afford every month
• Contact your original lender for a better deal
• Shop around to multiple lenders for the best deal

It’s important to take your time, do your research, and gather all the information you’ll need to make a well-educated decision. Refinancing your vehicle isn’t a decision you should make lightly. Many factors go into determining whether it’s a sound financial decision.

Common Pitfalls

There’s no easy way to say this, but if you’re in a difficult financial situation – such as being upside down on your car – sometimes you’ll take the first deal you can find because you think it’s the only option. But even if it is better than your current circumstances, take the time to do your research, including learning everything you can about your current loan terms and where you can find some wiggle room. More information means you’re set up to make better decisions.

A declined application isn’t always the end-of-the-line. Many consumers have errors on their credit reports that they don’t even know about, such as hospital bills that didn’t get reported as paid. It’s also possible you’ve been a victim of identity theft. When this happens, consumers often don’t find out until they try to get credit. Be sure to check your credit score, but also request a copy of your report. Read through it thoroughly and check for any errors. If you find one, follow the steps to dispute it with each of the three major reporting bureaus (Experian, TransUnion, and Equifax).

Whenever you consider an auto refinance loan, consider every factor so you can determine whether it’s right for you. It’s not uncommon to improve one factor – like lowering your monthly payment – at the expense of another. Maybe a lower payment means you’ll have to accept a longer loan term, and, as a result, you’ll pay more in interest over the loan term. These considerations are sometimes necessary (for instance, in the event of a job loss or reduction in income), but knowing exactly what you are agreeing to is important.

Just as all the factors could work in your favor, you can also experience the flip side and pay more overall. For example, burying negative equity in a new loan solves the short-term problem of owing more than your car is worth but also kicks the can down the road because you’re paying that difference in your new loan. Again, sometimes circumstances make these compromises necessary, but be sure to understand what you are agreeing to ahead of time.

Most importantly, find a reputable lender that will give you a loan that works for your individual circumstances. Many third-party lenders exist that make their loan programs sound like great deals, but you’ll need to read all the fine print and do some math to make sure what you’re hearing is what you’re getting. With a reputable lender you can trust, like our team of highly trained finance experts at McCluskey Auto, you’ll have the peace-of-mind of knowing that you’re in good hands.

Frequently Asked Questions About Refinancing a Car Loan

Now that you know a little bit more about the benefits and limitations of refinancing a car loan, you may have a few concerns, and you’re certainly not alone. There are many questions that arise about the car refinancing process, and we’ve compiled a few of the most common.

Q. How Does the Process Work?

A. Whether you’re refinancing a car or refinancing a home, the general process is very similar to how you applied for your original loan in the first place. A new lender will pay off your existing loan with your existing lender, thus taking the financial burden that you will be responsible for paying. This new lender will want to know that you’ll be able to make regular monthly payments so that it’s not a risk to take on this burden.

This is where financial elements of your life, like your credit score, payment history, and income, will need to be checked to verify that you’ll be able to pay your new lender. In some cases, you may be able to find a better rate with your existing lender; however, you will need to go through the entire qualification process all over again, just like you would with a new lender.

You’ll also be able to choose new loan terms, but it is advised to try and stick to the length of the loan you already have or a shorter loan period, if possible. Choosing longer loan periods may lead to smaller payments, but it also leads to more time spent paying on that loan and more interest charges adding up. Remember, you want to benefit from a refinance, not place yourself further into debt.

Q. How Long Do You Have to Wait to Refinance a Car Loan?

A. In reality, there’s no set time that you must wait to refinance a vehicle; however, there are some best practices so that you’re able to have the most success with the process. Typically, it takes about three months for the title of your car to transfer to your lender, and if your title hasn’t yet transferred, many lenders won’t consider you as a refi candidate. It also takes about six months to a year for your credit score to improve after running a credit check, which is why it’s recommended to wait so that you’re able to take advantage of the best possible rates.

Q. How Much Does It Cost to Refinance?

A. Many drivers are so focused on lowering their monthly payments that they may not realize that there could be fees associated with the refinancing process. This, of course, will vary depending on the lender, as well as where you live. Fees that you may be responsible for are early termination fees from your lender, transaction fees, and a title transfer fee, to name a few. Be sure to ask questions before you begin the process so that you’re prepared to pay out of pocket, if necessary.

Q. Does Refinancing Hurt Your Credit?

A. Some drivers have a misconception that refinancing their auto loan will severely impact their credit score. Although your credit will need to be checked again, thus adding an inquiry to your credit report, your overall score shouldn’t be affected too significantly. This makes it even easier for more drivers to get better auto loan rates so that you can keep more money in your pocket.

Q. Can You Refinance an Auto Loan With Bad Credit?

A. Just because your credit may need a little work, it doesn’t mean that you can’t refinance your car loan. It’s advised that if you want to qualify for the best possible loan terms, making more timely payments on your vehicle and paying off more debt is a good practice. This way, you’ll be able to improve your credit score and, in turn, qualify for a much better rate than if you were to apply with a lower score.

Q. Can You Remove a Cosigner From Your Loan If You Refinance?

A. For some drivers, a cosigner is required in order to qualify for a loan, and eventually, it’s a good idea to relinquish that cosigner from this financial burden. Refinancing is one of the ways to do this. Once you establish your credit and you’re confident that you can take over the payments for the vehicle, refinancing can remove your cosigner, allowing you to take responsibility for your loan. You’ll want to be sure that you alone will be able to qualify for financing and that you alone will be able to make the required monthly payments.

Q. Can You Refinance a Leased Vehicle?

A. Leasing a car may have been the best choice for your needs, but you may be wondering what options you have when it comes to your monthly lease payments. If you’re looking to refinance your lease, you’ll be able to do so at the end of your lease term. This option is known as a buyout, which is advantageous for those who wish to keep their current vehicle instead of trading it in for another leased model.

Q. How Many Times Can You Refinance a Car Loan?

A. There has to be a limit as to how many times you’re able to go through the refinancing process, right? Well, actually, there isn’t! You’re able to refinance your vehicle as often as you wish; however, there are some lenders that will have their own stipulations when it comes to the process. If a lender notices that you’ve refinanced your vehicle multiple times, they may not want to offer you a loan. Plus, the more you refinance, the more time you may be potentially adding to the length of your loan term, which can cause you to pay more in the long run. This is important to keep in mind so that you’re able to go about this to get the most benefit for you.

Q. Does the Current Value of Your Vehicle Matter?

A. The current value of your vehicle plays a crucial role in the refinancing process. This is a key element that impacts whether or not lenders would want to offer you a loan. Knowing what your car is worth is always advised, and it’s easy to get an idea of this through tools like Kelley Blue Book and NADA Guides. Think of it this way…the lender is taking a risk by buying a vehicle that is not yet paid for, and if you fail to make the monthly payments, the lender may be forced to take the vehicle back. They will then try and sell this vehicle, and if the value of the vehicle doesn’t match what the lender paid for it, they end up losing money in the end. This is why value is such an integral part of the process.

Q. Is Refinancing a Car Loan Worth It?

A. The answer to this is…it depends! For some drivers, refinancing their car loan to be able to take advantage of a better rate and lower monthly payments is absolutely the right move for their unique situation. For others, it may result in more money paid in the end, longer loan terms, penalties, and other fees stacking up. That’s why it’s important to do your research, be aware of your vehicle’s current value, your current credit situation, and market trends so that you’re able to have the most success with the refinancing process as possible. If you take all of this into consideration, you may just find that refinancing isn’t the best choice right now, or you may realize that it will positively impact your financial situation. The answer depends on you.

Questions? Comments? Concerns? Bring Them All to Us

Visit McCluskey Automotive today to learn more about our bad credit car loans and the interest rates available. You may be surprised to learn how affordable that car you need can be. Once you have an idea of what kind of financing you can get, explore our selection of quality automobiles and take a test drive of what could be your new car.

When you start with the right loan terms, you won’t have to worry about trying to refinance later. You can feel confident knowing that you have your finances under control.

You may have to pay a penalty.

Like all loans, your car loan may come with a penalty for early payment. That means that if you pay it off before a certain time, you may have to pay a fee. Therefore, refinancing your car loan too early may actually end up costing you money, rather than saving it.

Check the fine print on your loan paperwork to see if there are any prepayment penalties, and double check the time frame if there are.

Refinancing your car loan typically only makes sense if you have had a radical change in your credit or your financial situation or if interest rates have dropped considerably. If you are trying to lower your payments, it makes more sense to take out a home equity loan to pay off your car loan. You’ll get lower rates, and you can use the money for other financial needs.

If you have bad credit and are trying to keep your payments low, working with the right lender to get bad credit car loans can help. Some unethical lenders prey on those who have bad credit and will charge usurious interest rates for these bad credit car loans.

However, reputable dealerships like McCluskey Automotive offer fair terms that give those with bad credit a chance to get a quality automobile and to start rebuilding their financial future.

Visit McCluskey Automotive today to learn more about our bad credit car loans and the interest rates available. You may be surprised to learn how affordable that car you need can be. Once you have an idea of what kind of financing you can get, explore our selection of quality automobiles and take a test drive of what could be your new car.

When you start with the right loan terms, you won’t have to worry about trying to refinance later. You can feel confident knowing that you have your finances under control.