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reasons to refinance your auto loan

When people hear the term “refinance,” they often associate it with a long, tedious process. If you've ever refinanced a home mortgage, you know the complexity of those loans can make the process long and tedious. However, refinancing your car loan is quite simple and can usually be done in a day or two.

All rates shown on this page are for illustrative purposes only.

What is Refinancing?

In short, refinancing is the process of replacing your current loan with a new one. Typically, you’ll refinance a loan to make it more favorable for you – either through more flexible terms or better pricing. There are two common ways to refinance:

  • Current Lender: You may be able to refinance your existing loan with your current lender. This type of refinancing is more common when you’re looking to change up the length or terms of the loan. It’s not uncommon for lenders to restrict in-house refinances since this usually benefits you more than it does the financial institution.
  • New Lender: If you want to take advantage of lower interest rates or are unhappy with the initial terms of your loan, switching to a new lender is a common strategy. For example, if you originally financed your vehicle with a dealership, moving your loan to the credit union could help you take advantage of better interest rates.

When you refinance your loan, your existing loan will be paid off and closed. Then, a new loan will be created – either with your current institution or a new lender.

Reasons to Refinance Your Auto Loan

Your car payment is likely one of your largest monthly expenses. Refinancing allows you to reduce this expense and keep more of your hard-earned dollars. Here are four examples where refinancing could be in your best interest.

1. Interest Rates Declined

If rates have dropped since you initially financed your car, you should definitely consider refinancing. There is no reason to pay more interest than necessary. Here’s a quick example to illustrate how a decline in rates could benefit you:

     Loan Amount $30,000 $30,000
     Term of Loan 60 Months 60 Months
     Interest Rate 5% 3%
     Monthly Payment $566.14 $539.06
     Total Interest Paid $3,968.22 $2,343.64

The above example compares the same loan at different interest rates. If the interest rate drops from 5% to 3%, the monthly payment is reduced by $27.08. But more noticeable is the amount of interest you would save over the life of the loan – a whopping $1,624.58! Depending on your loan amount and current rates, these savings could be substantial.

2. Your Credit Score Increased

Lenders will typically use your credit score to determine how much you will pay for your loan: the better your score, the lower your interest rate. Financial institutions use this pricing strategy to help offset the risk they assume when lending money.

The following is an example of how a lender might price their auto loans.

Credit Score Interest Rate
800 and Up 3.49% APR
750-799 3.99% APR
700-749 4.99% APR
650-699 5.99% APR
600-649 6.99% APR
550-599 8.99% APR

Assume your credit score was originally 655 when you financed your car loan. Using the rates above, your interest rate would be at 5.99% APR. However, if you improved your score and it’s now 780, you would qualify for the 3.99% rate – allowing you to save a significant amount of money each month and over the life of your loan.

3. You’re Facing a Financial Setback

Life is full of financial curveballs. From unexpected expenses to sudden job losses, a financial setback can come at any time. If you need to free up extra money in the short term, extending your loan’s term can help.

     Loan Amount $30,000 $30,000
     Term of Loan 60 Months 72 Months
     Interest Rate 3% 3%
     Monthly Payment $539.06 $455.81

Continuing with the example from earlier, notice the change in your monthly payment if you extend the loan term by a year from 60 months to 72 months. Your payment will drop to $455.81 and save you $83.25 each month. Depending on your loan amount and current rates, this strategy could free up extra cash to help you get back on financial track.

4. Your Loan is Underwater

Being underwater or upside down on your loan refers to when you owe more than the car is worth. This situation frequently happens when people finance cars directly with dealerships. Dealers are notorious for selling add-on products – everything from scratch protection to extended warranties. Many people don’t understand that these products are added to the loan. Coupled with the fact that vehicles depreciate quickly, the car buyer is left owing more than the car is worth.

To correct this situation, you might consider shortening your loan term. While this will increase your monthly payments, it will help you build equity in your vehicle and get your loan back on track. For example, you might shorten your loan term from 60 to 48 months.

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