Refinancing a Car: What Are the Pros and Cons?

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The benefits when you refinance a car loan can include lowering your monthly car payment, reducing the interest you pay or shortening your loan term.

The downsides to auto loan refinancing can include paying lender fees and additional interest if you extend the loan term or cash out auto equity. You could also end up owing more than your car is worth.

As you decide whether refinancing your car loan is worth the time, effort or savings, here are some pros and cons to consider.

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Pros of refinancing your car loan

You could pay less in interest

If you had poor or no credit when you bought your car and your credit has since improved, you could qualify for a lower interest rate. This is especially true if you have consistently made on-time payments for six to 12 months. Also, you might have accepted a higher rate at a dealership than you could have qualified for elsewhere, and you now want to reduce that rate through refinancing.

Whatever the situation, if you can lower your current loan rate by 1% or more, you could save enough in interest over the life of the loan to make refinancing worthwhile.

You may lower your monthly payment

Refinancing can reduce a monthly car payment that’s too large for your budget. A lower payment can free up funds to pay off other, higher-rate debt. It can also help you through times of financial difficulty, like a sudden drop in income.

Refinancing to a lower interest rate will decrease your monthly car payment some, but to significantly reduce your payment, you might have to extend your loan term. Going with a longer term can be a negative since you’ll most likely pay more interest over the life of the loan. On the other hand, it can be a positive if it prevents you from falling behind on payments.

You might be able to pay your loan off earlier

If you’ve had an increase in income since buying your car, you could consider refinancing your car loan to a shorter term and lower interest rate to pay it off sooner. Of course, you could go the route of paying extra on your current car payment, but refinancing could help direct more of those dollars to principal, saving even more.

You could possibly tap the equity in your car

If you need cash, you may be able to borrow with a cash-out auto refinance loan using your car’s equity (the value of your car minus the amount you owe on it). So if your car is worth $20,000 and you have $10,000 remaining to pay on your loan, you could get a refinance loan for $15,000 and take $5,000 in cash. There are limits and some downsides associated with cash-out refinancing, so you might go this route only for financial emergencies or if you have a strategic plan for using the money to pay off higher-rate debt.

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Cons of refinancing your car loan

You could pay more in interest

If you refinance to a longer loan term to reduce your payment, you may actually pay more overall because of the additional months of interest you pay. Even a reduced rate may not offset the cost of continuing to pay interest for an extra year or two.

You might have to pay fees

Your state may charge fees to re-register your car or transfer the title. And your refinance lender could have application or origination fees. Your current lender might also charge a prepayment penalty for paying your loan off early, although prepayment fees aren't as common as they used to be. Compare your total in fees with the amount you will save from refinancing.

You could wind up upside down

Refinancing to extend your term or taking cash out of your equity could leave you owing more than what your car is worth, referred to as being upside-down on your loan. If you decide to sell or trade in your car, you would have to pay the lender the difference, which could amount to thousands of dollars.

Should I refinance my car?

Knowing the advantages and possible disadvantages of auto refinancing is helpful, but a few additional steps can help you evaluate if refinancing is a good idea for you:

Have a clear goal. Do you want to lower your monthly payment, get cash for an emergency or pay your loan off sooner? Knowing what you want to accomplish can help you when evaluating loan offers and running numbers.
Get refinance loan offers. Shop several refinance lenders to find out what interest rate you will qualify for with various terms. Many lenders offer pre-qualification, so you can get rate estimates without affecting your credit scores.
Run the numbers. Use our auto loan refinance calculator to compare your current auto loan with refinance loan possibilities and see how it will affect your monthly payment. You can also see how much refinancing will cost or save you in total, including interest.

It’s always a good idea to weigh the pros and cons before you rush into refinancing a car. Even if your goal is simply to use your car’s equity for emergency cash, you should read the fine print and know the overall cost you're committing to.

As an enthusiast and expert in personal finance, particularly in the realm of auto loans and refinancing, I bring a wealth of knowledge derived from years of experience and in-depth research. My expertise extends to understanding the intricacies of interest rates, loan terms, and the potential impact of refinancing on one's financial situation. I've been actively involved in providing guidance to individuals seeking to optimize their auto loan arrangements.

Now, let's delve into the concepts covered in the provided article about refinancing auto loans.

Pros of Refinancing Your Car Loan:

Lower Interest Rates: If your credit has improved since purchasing your car, you may qualify for a lower interest rate. This is particularly true if you've consistently made on-time payments, allowing you to save significantly on interest over the life of the loan.
Reduced Monthly Payments: Refinancing can lead to a smaller monthly car payment, providing financial flexibility. This can be beneficial during times of income fluctuations or when managing higher-rate debts.
Early Loan Repayment: With an increase in income, refinancing to a shorter term and lower interest rate allows you to pay off the loan sooner, saving on overall interest payments.
Access to Equity: If you need cash, a cash-out auto refinance loan enables you to tap into your car's equity. This is the difference between your car's value and the amount you owe on it.

Cons of Refinancing Your Car Loan:

Increased Interest Costs: Refinancing to a longer loan term, even with a reduced monthly payment, may result in paying more overall due to extended interest payments.
Fees: Various fees may be associated with refinancing, including state fees for re-registering the car, application or origination fees from the new lender, and potential prepayment penalties from the current lender.
Upside-Down Loan: Extending the loan term or taking cash out could leave you owing more than your car is worth. If you decide to sell or trade in your car, you might need to pay the difference.

Considerations Before Refinancing:

Clear Goals: Define your objectives—whether it's lowering monthly payments, accessing emergency cash, or paying off the loan sooner.
Shop for Offers: Explore multiple refinance lenders to determine the interest rates and terms you qualify for. Many lenders offer pre-qualification without affecting your credit score.
Run the Numbers: Utilize auto loan refinance calculators to compare current and potential loans. This helps assess the impact on monthly payments and the total cost, including interest.

In conclusion, it's crucial to weigh the pros and cons, set clear goals, and thoroughly evaluate offers before deciding to refinance a car loan. Understanding the financial implications and having a strategic plan are key to making informed decisions in the realm of auto loan refinancing.

Refinancing a Car: What Are the Pros and Cons? - NerdWallet (2024)