When Does It Make Sense to Refinance Your Auto Loan?

When you refinance an auto loan you are essentially paying off your existing loan and replacing it with a new one, under different terms. Unless you opt for a cash-out refinance, the new loan amount will be equal to the outstanding loan balance, with the vehicle still serving as collateral. The main reason that people refinance their loans is to either shorten or lengthen the loan duration, or to obtain a lower interest rate so they can pay less over the life of the loan. However, a longer loan term could translate into higher cumulative interest charges because you’ll be paying for the loan for a longer period while accumulating interest. Conversely, a shorter loan term will usually mean a lower interest rate and overall cumulative charges.

Refinancing only makes sense when you are able to obtain a lower interest rate, lower monthly payments or both. If interest rates have dropped considerably since you took out your original auto loan, it could make sense to refinance while a larger portion of monthly payments are still going towards interest instead of the principal loan amount. That is because you pay the most towards interest at the beginning of the loan term. Over time, more and more of your monthly repayment goes towards the principal amount and less towards interest, so you will probably want to refinance when your outstanding loan balance is at its highest. Again, be wary of refinancing for a much longer term that could mean that you pay more in interest over the life of the loan.

To ensure you’re getting a good refinance deal, compare your current monthly payments with the new payment amount. Then, take the difference in monthly payments and divide that by the closing costs of the new loan. The result will be how many months it will take you to recover those fees. If it’s a reasonable amount, or you are able to switch from a variable interest rate to a fixed rate, it makes sense to refinance as soon as possible. However, loan rates can change throughout the day and each lender may offer different closing costs with added fees, so you may want to shop around and compare offers using the same loan amount, terms and duration. Again, if your interest rate is very high and you are just beginning to make payments on your auto loan, look to refinance as soon as possible. Looking into a credit union or community bank can possibly offer you a lower interest rate, as well as a reasonable loan duration and closing costs.

Before opting to refinance or take out any type of loan, check your credit score and learn how it can affect interest rate offers. If possible, opt for a shorter loan term that can afford you a lower interest rate, even if your monthly payments end up being higher. If you’re not able to afford a higher monthly payment, choose a longer loan duration, but aim to pay more than the minimum each month, so you can lower cumulative interest faster. Look for online resources and tools such as auto loan refinance calculators, and make sure to compare as many options as you can, always obtaining new loan details in as short a time frame as possible to avoid very disparate interest rate offers. Auto loan refinance calculators are easy to use and will typically just require basic loan details such as the original loan amount, the refinance amount, current monthly payments, the new loan term in months, the current rate, and the new interest rate.