When to Refinance Your Car Loan

If you’re looking to lower your car loan’s interest rate or monthly payments, refinancing can be a smart financial move. This typically involves replacing your current loan with a new one, typically with a different lender, to better suit your financial situation.

But when should you refinance your car loan? The answer depends on several factors, including changes in interest rates, improvements in your credit score, your ability to manage current monthly payments and shifts in your overall financial circumstances.

When refinancing your car loan, it's important to take into account factors like changes in market interest rates and shifts in your particular financial situation to make a well-informed decision that optimizes your financial well-being.

When you took out your original auto loan, the interest rate you received was likely based on a variety of factors, including the market rate at that time. If interest rates in the market have since decreased significantly, refinancing could potentially save you a substantial amount of money.

Suppose you took out a car loan for $20,000 at a 7% interest rate for a term of 60 months. Your monthly payment would be approximately $396, and over the life of the loan, you'd pay about $3,760 in interest. Now if rates have dropped and you can refinance that same loan at a 4% interest rate, your monthly payment would decrease to roughly $368, and you'd pay around $2,080 in interest over the life of the loan. That's a savings of nearly $1,680 in interest payments.

An improved credit score can open the door to refinancing your car loan on more favorable terms. When you initially took out your car loan, your lender determined your interest rate based on your credit score at that time. If your credit score has since improved, you may qualify for a lower interest rate, which can lead to significant savings.

Credit scores are a measure of a borrower's creditworthiness, with lenders using them to assess the risk of lending money. A higher score often indicates a lower risk, which can translate to lower interest rates. So if you've been diligently making timely payments on all your debts — not just your car loan — and your credit score has risen, it might be time to consider refinancing.

Having expensive monthly payments can become a burden, especially if your financial circumstances have changed since you took out your car loan. If you're finding it difficult to manage these payments, refinancing could be a viable solution. By extending the term of your loan, you can reduce the amount you pay each month, making your financial obligations more manageable.

Let’s say you originally took out a car loan for $20,000 with a term of 36 months at an interest rate of 5%. Your monthly payment would be approximately $599. However, if you're struggling to make the monthly payment, you could refinance the remaining balance of your loan to a new term of 60 months. This would lower your monthly payment, although it's important to note that you would end up paying more in interest over the life of the loan.

A change in your financial situation can be a compelling reason to refinance your car loan. If your financial circumstances have improved, such as if you've received a raise at work or landed a job with a higher salary, you might find yourself in a position to afford higher monthly payments. In this case, refinancing your car loan to a shorter term could be a beneficial move.

While this would increase your monthly payments, it would also allow you to pay off your loan faster. This could save you a significant amount in interest over the life of the loan. It's a way of leveraging your improved financial situation to reduce your debt more quickly and pay less to your lender in the long run.

Having positive equity can be advantageous when you're looking to refinance because it indicates to lenders that the loan is less risky. This is because the car itself, which serves as collateral for the loan, is worth more than the loan amount. This could potentially lead to more favorable terms like a lower interest rate, which could save you money over the life of the loan.

To determine if you have positive equity, you'll need to estimate your car's current value and compare it to your outstanding loan balance. Use online tools like Kelley Blue Book or Edmunds, which provide an approximate value based on your car's make, model, year, mileage and overall condition. Once you have this estimate, compare it to what you still owe on your car loan. If your car's value is higher, you have positive equity.

While refinancing your car loan can offer several benefits, there are situations when it might be best to hold off.

Lenders often view older or high-mileage vehicles as riskier investments. That’s because as a car ages, its value typically depreciates, and high mileage can lead to more wear and tear. If the car's value falls below the remaining loan balance, lenders may be hesitant to refinance, fearing they won't recoup their money if the borrower defaults.

Additionally, if your car is older or has high mileage, it's likely closer to the end of its life. If you refinance to a longer loan term to reduce your monthly payments, you could end up still making payments on the loan even after the car is no longer drivable.

If you're close to paying off your car loan, it might be more beneficial to stick with your current loan rather than refinancing. When you refinance a loan, there are often costs involved, such as origination fees or transaction fees. If you're near the end of your loan term, the amount you could save through refinancing might not be enough to offset these costs.

Refinancing to a new loan also resets the clock on your repayment schedule. If you're close to being free of your car loan, refinancing could mean extending the time you're in debt. Even if the new loan has a lower interest rate, extending the loan term could result in you paying more interest over the life of the loan.

Prepayment penalties are fees that some lenders charge if you pay off your loan before the end of the term. They're designed to compensate the lender for the interest they would have received if you had paid the loan according to the original schedule.

If your current car loan has a prepayment penalty, it could make refinancing less advantageous. The cost of the penalty could offset any savings you might gain from a lower interest rate or a longer loan term through refinancing.

For example, if your prepayment penalty is $300 and the total amount you would save through refinancing is $200, you would actually lose money by refinancing. In this case, it would be more cost-effective to continue with your current loan.

Negative equity, often referred to as being “upside down” or “underwater” on your car loan, occurs when you owe more on your car loan than the current market value of the car. Refinancing a car loan when you have negative equity can be challenging as many lenders are hesitant to take on the risk.

Even if you find a lender willing to refinance, the terms may not be favorable. You may face a higher interest rate or be required to pay a larger down payment. Additionally, refinancing doesn't eliminate negative equity; it only extends the time you'll be dealing with it.

Refinancing a car loan often involves various fees, and in some cases, these costs might outweigh the potential benefits of a new loan. Common fees associated with refinancing can include loan application fees, loan origination fees and transaction fees. These costs can add up, and if the total is higher than the amount you would save through refinancing, it may not be a financially beneficial move.

For example, if the total cost of your refinancing fees is $500, but the total amount you would save on interest by refinancing is $400, then refinancing would actually cost you an additional $100. In this scenario, it would be more cost-effective to stick with your current loan.

Refinancing your car loan can be a strategic move to lower your interest rate or reduce monthly payments. However, it's a process that requires careful consideration and planning. Here are some important steps you should take to make an informed decision.

To help you decide whether and when to refinance your car loan, we've compiled answers to some frequently asked questions about the refinancing process.