If you own a home or are in the process of buying one, you’ve probably heard the term refinance. Refinancing can mean different things depending on who you’re talking to, but the basic concept is that you’re replacing one loan for a home with another that has different terms. The lender pays off the old loan, and you begin making payments on the new agreement. What you may not know is that refinancing can also be a great way to cut your monthly car payments, though there are several things you’ll need to keep in mind as you proceed.
Refinancing Car Loans: How it Works
Cars, like homes, come with long-term loans that let you pay them off over a period of years. Though auto loans are stretching longer as time goes on and vehicles become more expensive, the loans are generally between three and six years long – far shorter than a mortgage on a home. Even though the term is shorter than the loan you took to pay off your home, you may still find a situation in which you’ll be better served with different loan terms.
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It's completely possible to refinance a car loan. Banks and credit unions are generally happy to help you refinance if your credit is in line and the vehicle’s condition and value are solid. You might even be able to refinance with the same lender, though it always pays to shop around. Applying to refinance a vehicle is similar in process to getting the original loan, and you might be required to provide a credit background, employment verification, or other identifying documents.
When you Refinance a Car Loan what Happens?
Once approved, your new lender will pay off the old loan, even if it’s held at the same bank. You’ll stop making payments on the old loan and pick up paying on the new one under the revised terms. Though your original loan gets paid off during the process, you still won’t own the vehicle, as the title will be held by the new lender.
Why Refinance a Car Loan
People refinance car loans for various reasons, including lowering their monthly payments or getting a more agreeable interest rate. Some may choose to refinance with a different lender if their primary bank becomes hard to deal with or lacks solid customer service. That said, refinancing a car can come with risks that refinancing a home doesn’t.
Cars are depreciating assets, meaning they lose value with use and time instead of growing in value, (usually) unlike a home. When a bank issues a loan for a vehicle, it realizes that the window of time to recoup that money is short and that the vehicle as collateral won’t be worth much if it’s worn out. That presents a risk to the lender in that it might not get its money back, but it’s also a risk to the borrower. Extending the length of a loan on a depreciating asset can be a risk because the borrower could easily end up owing more than the car is worth. Extending loan terms longer than necessary is generally a bad idea, so refinancing should come with a healthy dose of caution.
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Even with the risk, the drop in monthly payments that comes with an interest rate reduction can’t be ignored. Refinancing a loan after the first year could save hundreds of dollars over the remaining loan term if interest rates have dropped.
Can you Refinance Car Loan with Bad Credit?
It's possible to refinance a car loan when your credit isn't in the best shape, but it might not yield the results you're hoping for. If your credit has declined since you first bought the car, you might be looking at a higher interest rate and worse terms than you currently have. If you've missed multiple payments and have spotty histories with other lenders, you might be denied outright. As with any financial decision, it pays to shop around to find lenders that are willing to work with your credit situation. Be careful to read and understand your loan agreement and take the time to compare the new terms and rates to your current loan. It might feel good to shift lenders or change loan terms, but it only makes sense to do so if it improves your situation.
When Refinancing A Car is Not Worth It
If you’ve almost completed the original loan term and are looking at less than a year of payments to finish the auto loan, it’s probably best to wait it out. Once you’ve reached the end of a loan term, most of the interest has been paid off, so you won’t get the benefit of a rate cut like you would in a normal refinancing situation. You may also find that fees and other charges make refinancing more financial hassle than it’s worth. This is especially true for prepayment fees and other costs related to early loan repayment.
Finally, you might not be a great candidate for refinancing if your car is older and has higher mileage. Beyond the fact that lenders don’t want to be on the hook with a worn-out vehicle should you default, there isn’t as much value in very used cars, so your loan amount and interest rates might not be so agreeable.
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