Refinancing a Car: What Are The Pros and Cons?

Feel stuck with a car loan you hate? Paying a high interest rate on that financing? Perhaps it’s time to consider replacing this debt with an all-new car loan – ideally one with lower costs and better terms.

But before pulling the trigger, it’s smart to weigh the pros and cons of refinancing an auto loan. Read on for analyses and tips from the experts that can help you make a more informed decision.

What’s involved with refinancing

Refinancing an existing car loan is not only possible: It can also be a shrewd financial move under the right scenarios.

“Essentially, refinancing involves taking out a new loan to pay off the existing one, preferably with better terms such as a lower interest rate or extended repayment,” says personal finance Michael Ashley with Richiest.com. 

Most borrowers pursue a car loan refi to lower their monthly payments, which is achievable if you can lock in at a lower interest rate and/or extend the repayment term.

However, there are limitations and rules to ponder, including the lender’s qualification criteria, today’s market interest rates, and any fees tacked on to the refinancing process. 

Good candidates and reasons to refinance

Refinancing makes the most sense if you can take advantage of lower rates, the pros agree.

“It’s feasible when interest rates have noticeably dropped since the inception of the existing loan or if there is a significant improvement in your credit rating,” explains attorney Jonathan Feniak. 

Worthy prospects for refinancing a car loan include those who initially had high interest rates because of poor credit and have since improved their credit scores, people seeking to pay less every month, or anyone aiming to secure more favorable loan terms.

“Also, if your financial circumstances have changed since you got your original loan – such as a higher income – you might qualify for better interest rates through refinancing,” Ashley points out.

However, “individuals near the end of their loan term, borrowers who have already paid off a significant portion of their principal, or those with loans that charge significant prepayment penalties might not find refinancing advantageous,” cautions Geoff Cudd, a consumer advocate and owner of FindTheBestCarPrice.com. 

The pros of refinancing

The biggest advantage of refinancing is the opportunity to pay less per month and save money otherwise spent on interest.

Case in point: Let’s say you borrowed $40,000 for a 60-month car loan two years ago at a 7% fixed interest rate. If so, your monthly payment would be about $792. If you pay all 60 months, you will have forked over around $7,523 in interest. 

But if you refinance after month #24, borrowing the $25,000 you still would owe on the vehicle but capitalizing on a now lower 5.5% fixed interest rate, your new monthly payment would drop to approximately $755. Additionally, you would pay less in total interest: $6,837 ($2,176 for the new loan plus the $4,661 you already paid over the 24 months of your earlier loan).

In other words, refinancing would save you around $686 in interest. 

“This move puts more money back in your pocket,” says Ashley. “Or, refinancing could provide the opportunity to lengthen your loan term, offering more flexibility in managing your finances and potentially freeing up cash flow for other priorities.”

Note that some lenders will allow you to refinance to a new car loan term up to 96 months, although 24, 36, 48, 60, 72, and 84 months are the most common lengths. 

The cons of refinancing

You may find that the costs involved with refinancing outweigh the financial benefits you could reap. That’s especially true if your current loan charges prepayment penalty fees for paying off your existing financing early, or if there are other expensive fees or closing costs involved with a refinance loan.

“These could include application fees or origination fees,” warns Ashley. “It’s crucial to factor in these costs when evaluating whether refinancing is a good idea.”

Refinancing to lengthen your loan term has a big downside. While it can make your monthly payments more manageable, you’ll likely end up paying more in total interest over the life of the loan because you chose to extend the term and suffer the consequences of accrued interest over a longer span.

There’s also the risk that the vehicle could get repossessed and you may severely harm your credit if you can’t repay your refinance debt. 

“Keep in mind, as well, that refinancing can impact your credit by temporarily lowering your credit score. That’s because the new lender will need to do a hard inquiry of your credit, although it should only drop your score between one and five points,” says Dayten Rynsburger, CRO of Niche Capital CO. 

Fortunately, your credit score should rebound after you demonstrate a history of making on-time payments toward your new loan.

“Also, if you’re approved for a lower interest rate or better loan terms through refinancing, it can demonstrate responsible financial behavior and potentially improve your credit score over time,” continues Ashley.

Steps involved with refinancing

The process of refinancing a car loan is similar to what’s involved with refinancing a mortgage loan or other type of financing. Here are the common steps:

1. Check your three free credit reports. If you notice any inaccuracies or errors, report them to the three major credit bureaus (TransUnion, Experian, and Equifax) and have them corrected.
2. Know your credit score, which your bank or credit card may provide for no charge. If it’s lower than desired (aim for 720 or higher), consider postponing a refi for a few months. Over that time, make efforts to up your score by always making on-time payments, paying off your monthly credit card balance in full, paying down any outstanding debts, asking your bank or credit card issuer for a credit limit increase, not closing any old established credit accounts, and enroll in Experian Boost for free.
3. Find out if there are any restrictions or penalties for paying off your existing car loan early, and determine if pursuing a refi is worth it.
4. Shop around among different lenders, scrutinize offers, including interest rates, terms, and fees, and choose the best lender/deal.
5. Gather all necessary documentation, such as proof of income, bank statements, and current loan information.
6. Submit a completed application for a car refinance loan.
7. Await an underwriting decision, which will occur after the lender checks your credit and documentation.
8. Close on the loan and begin making monthly payments.

Is refinancing a car worth it?

The choice to refinance a current car loan or not will depend on your personal circumstances and financial objectives.

“If you stand to save money through lower interest rates or reduce monthly payments, it could be a very smart move,” Ashley suggests.

Crunch the numbers, evaluate your earnings and ability to repay your car financing debt, ponder all fees and costs involved, and make a decision after evaluating all the factors and scenarios.