Money Moves — Should I Refinance My Car?

When you take out a new loan — whether it's a student loan, a mortgage or an auto loan — the interest rate is important. The interest rate is essentially the cost of borrowing money. If you have a high interest rate, you'll pay more money to your lender over time. 

Sometimes, you have the option to refinance your loan. This offers you the opportunity to lower your interest rate, which can save you money, since you won't have to pay as much interest to your lender. A lower monthly payment can fit into your budget more easily and free up cash for other things, like paying down existing credit card debt or putting money into a savings account. 

If you’re wondering, "Should I refinance my car?" take a look at the pros and cons of refinancing a car below and the situations when it may be in your best interest to do so. 

Whether you currently have a car loan or are thinking of getting one in the future, this article can help you manage your car financing. 

How refinancing a car works 

Typically, auto loan refinancing works in one of two ways:

1. You negotiate your current auto loan with your existing lender: If you have a good payment history with the lender — meaning you've made your monthly car payments on time and in full — the lender may be more willing to negotiate a lower interest rate rate on your existing loan.

2. You take out a new loan with a different lender: Under this option, the principal balance on the new loan is used to pay off your initial loan balance. From there, you continue making loan payments, though you’re making them to the new lender.

The pros and cons of refinancing a car

Sometimes it helps your financial situation to refinance your car and sometimes it doesn't. Here are some pros and cons to help you decide if it makes sense. 

Pros of refinancing 

A car refinance can be beneficial if your credit score has improved or industry-wide interest rates have dropped. Let's take a closer look at some of the upsides that come with refinancing your current car loan. 

Find a better interest rate 

A particularly obvious benefit of refinancing is that you may end up paying a lower interest rate, which saves you money in the long run. 

Let's say you take out an auto loan for $30,000 with a 4% interest rate and a loan period of 60 months. The actual cost of the car with interest is $33,150 and your monthly payment is $552. 

Now, let's use the same $30,000 loan, but this time your interest rate is 3% instead of 4%. Your monthly payment is $539 and the total cost of the car with interest is $32,344. 

With a 1% higher interest rate, you end up paying $806 more over the length of the loan. By securing a better interest rate, you can potentially save yourself money. 

Free up cash for other endeavors 

Lowering your interest rate can free up your monthly cash flow. This can have a tremendous effect on your personal finances. Even if you only save $20 per month, you'll end up with an extra $240 per year that you can put toward paying down existing credit card debt or building a rainy day or emergency fund. 

Build credit 

Refinancing can potentially make repayment easier, since you may be lowering your monthly payment. This can increase the likelihood that you make your payments on time and in full, which can have a positive impact on your credit report. Building credit can help with other financial priorities, like securing a mortgage. 

Cons of refinancing 

Though refinancing may be enticing, there are a few potential downsides to consider. 

Time spent researching a new loan 

Not only does it take time to research the conditions and requirements of your existing loan, but also to shop around for the best rates with other lenders. This is why refinancing can take dozens of hours, if not longer. 

Granted, the end result could be you saving money, allowing you to accomplish other financial goals in the long run. But the process of closing a loan and finding a new one with better terms requires time and research. 

Impacts to your credit score 

Applying for a new loan can hurt your credit score. Your new lender is going to perform a hard inquiry to view your credit history. This can lower your score, but making payments on time and in full can quickly mitigate the short-term decrease. 

However, if you’re considering making a big credit move in the near future — like securing a mortgage — you’ll probably want your credit score to be as high as possible. So, it may make sense to hold off on refinancing your auto loan. 

A potential increase to your total interest payment 

As a borrower, it’s important to be mindful of the terms on the loan. Lenders may give you a lower interest rate but a longer loan term. This could actually end up increasing the total amount you pay in interest. 

Let's use the example above and assume your interest rate is at 4% on a $30,000 loan. You have 30 months remaining. You are paying $539 per month. This means you have $16,170 left to pay, $15,000 of which is principal. If you pay down the balance of the loan immediately, you won’t owe the remaining interest, which in this case is $1,170. 

You take out a new loan for $15,000 to pay off the outstanding principal. Your interest rate is 3.5%. However, the term of your loan is 55 months. This may seem enticing because the rate is lower. Your monthly payment is now only $296. But, because you’re paying this out over 55 months, the total cost of the loan is $16,257. This is $87 more than it would have been with the old loan. 

Plus, by extending the loan, you increase the likelihood of missed payments. It's important to consider the big picture to determine how refinancing could impact your credit and budget. 

Ending up upside-down on the loan 

Something else to be wary of when refinancing is ending up upside-down, or underwater, on the loan. Though cars are an asset, they lose their value very quickly. If you extend the life of the loan too long, you’ll end up owing more on the loan than the car itself is worth. This means your car is no longer an asset and you’re losing money by owning it.

It's an extreme example, but take a BMW 7 Series. The car has an average starting MSRP of $86,000. However, within five years, it depreciates by an average of $74,000. This means that after five years, the car is only worth $12,000. If you refinance halfway through your loan, you may end up paying the car off over six or seven years. In the final years of your loan, the money you owe your lender will be greater than what the BMW is worth. 

Things to research before refinancing 

Whether or not you should refinance can have a lot to do with your financial situation as well as the terms of your current loan. If you’re considering refinancing, look into these things first. 

Refinancing requirements 

Your current lender may have refinancing requirements in place, which means if you want to refinance, you'll need to meet some stipulations first. For instance, if the balance on your original loan is lower than a certain threshold, you may not be eligible to refinance. 

There may also be requirements tied to the car itself, such as if you financed a new car vs. a used car or if your car has a certain number of miles on it. For instance, Bank of America typically doesn’t allow you to refinance if your car has more than 125,000 miles on it. 

Talk with your lender to find out if you meet the eligibility requirements for an auto loan refinance. As mentioned previously, you may be able to secure a loan with a new lender and use those funds to pay down your existing loan amount. Doing so could help ease some of the refinancing requirements your current lender has in place. 

Prepayment penalties 

Using a new lender to secure a better auto loan rate may seem like an easy financial decision, especially if it means saving money. However, your current lender may have penalties in place to prevent you from paying your balance in full too early. 

The amount you save by refinancing could be worth it, even with the prepayment penalties. There are auto loan calculators available online to help you determine the true cost of paying off your loan early. 

Your personal finances 

Your financial situation could have changed since you first took out your auto loan, particularly your credit score. If your credit score has improved since you took out your first loan, you may have a much easier time securing a better interest rate. 

On the other hand, if your credit score decreased since you last took out your auto loan, you may not be able to find a better rate than the one you already have, or you may need to spend more time shopping around with different financial institutions to find a favorable refinance rate. 

Be aware of how your new payment is going to fit into your overall financial picture. If you have longer repayment terms, you may have a lower payment month-to-month, but the total interest you pay over the life of your loan may increase. Evaluate how your new payment will fit into your budget. 

Should I refinance my car? 

Refinancing a car loan can be a useful option for some, though whether it's right for you will depend on your financial situation and the terms of your original loan. It's important to focus not only on the interest rates themselves, but also on how refinancing will impact your credit score and the amount you pay over the life of the loan. 

If you don't think refinancing is right for you, there are other ways to reduce your monthly expenses and free up cash in your budget. 

One way is to use Tally†, a credit card payoff app. Tally can help you pay down your credit card balances quickly and efficiently, so you can steer clear of high-interest credit card payments.

†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 - $300.