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5 Reasons to Refinance Your Auto Loan

The Motley Fool logo The Motley Fool 4/14/2021 Dana George
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The moment interest rates drop, the mortgage refinancing buzz begins. Yet we rarely hear anything about refinancing auto loans. It may be because homes are more expensive than vehicles, and refinancing a house makes a bigger financial splash. Perhaps it's because homes are refinanced more frequently than cars are. Whatever the reason, here are at least five times it pays to consider refinancing your vehicle:

1. Your credit has improved

Let's say you purchased a car right out of college, before you had a chance to build a credit history. Since that time, you've held a job, taken on new debt, and paid off some old debt. In other words, your credit history has grown, and your ability to manage money is evident to anyone who checks your credit score. The "so-so" interest rate of 7.5% you were offered back then can now be replaced with a lower rate.

You know it's time to consider refinancing when you put pen to paper and learn that you can save money and avoid overpaying for an auto loan. For example:

  • If you borrowed $25,000 at 7.5% for five years and have already made 24 payments of $501 per month, you still owe $16,106, and you've paid $3,127 in interest.
  • If you refinanced the remaining balance for 36 months at an APR of 3.25%, your monthly payment would drop by $31 to $470. Better yet, by the time the car is paid off in 36 months, you will pay only $820 in interest.

2. You didn't shop around for your first loan

If you were in a hurry to buy a car or simply did not realize the value of rate shopping, it's possible that you purchased a vehicle at a higher interest rate than was necessary. If you realize now that you could have snagged a better rate and minimized your auto debt, it's not too late to refinance the loan with another lender.

3. You need to lower the payment

As the example above shows, it is possible to lower your monthly payment without extending your repayment term. However, if you're having trouble making your current payment, you also have the option of taking out a longer loan. Here's how that might look:

  • You borrow $25,000 for 48 months at 3.75%. Your monthly payment is $562.
  • You realize within the first month that you're going to have trouble making the payment, so you refinance the vehicle for 72 months, also at 3.75%. Your monthly payment drops to $389.

In this case, refinancing saves you $173 per month. But because you'll be paying interest for 24 extra months, the loan will end up costing an additional $856. If you're cutting your budget to the bone and the choice is between refinancing for longer or paying bills on time, paying your bills on time is always the right decision.

4. You want to shorten the length of the loan

Maybe you got a promotion or your business has picked up and you have more income each month. You decide that you want to save on interest payments by shortening the length of the loan. As long as your new rate is as low or lower than your original rate, you'll always save by paying the loan off sooner than originally planned.

5. You have access to a great deal

Some lenders offer cash back incentives to people who refinance their auto loans from another lender. If the interest rate they're offering is as good as (or better) than the rate you currently carry, it can make sense to switch lenders, refinance, and use the cash back to cover other financial priorities.

One caveat: These promotional incentives sometimes include "no payments for 45 to 90 days," which can be great if you're in the middle of a financial crisis. However, interest continues to accrue during periods of deferment, and allowing interest to build during that time will end up costing you more by the time the loan is paid in full. If possible, keep making payments, even when you could defer them.

Take a moment to check the interest rate on your auto loan. If it's not as low as you would like and your credit score is high enough to qualify for a better loan, there's no good reason to hold on to the old loan. It's all about keeping more money in your bank account.

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