Wednesday, 31 March 2021

You've probably heard of refinancing a mortgage. But did you know you can also refinance your auto loan?

Refinancing simply means taking out a new loan to pay off your existing loan. You would typically do this to get a term or payment that better suits your current financial situation, or to save money.

Here are a few instances in which refinancing your auto loan could be a smart financial move.

1. When interest rates have gone down

Interest rates have been relatively low for the past decade. However, the Federal Reserve, which conducts the nation's monetary policy and regulates banking institutions, dropped rates to near zero in March 2020 in response the coronavirus pandemic. This, in turn, caused the rates on many financial products like loans to drop as well.

So, if you got your auto loan before March 2020 and you haven't refinanced since, you might be able to refinance and lower your rate.

What's the benefit of lowering your rate? That's easy: it typically saves you money.

In most cases, getting a lower rate lowers your monthly payments and also reduces the interest you pay over the life of your loan. You'll need to run the numbers, but if you could get a rate that's even a few points lower than your existing rate, it could be well worth refinancing.

2. When you want to change your monthly payment or length of your loan

Car loans are typically in 12-month increments and, depending on the lender, can range from 24 to 84 months.

In general, the longer the term, the lower the payment since you are stretching repayment out over a lengthier period of time. However, a longer term also means paying more interest for the same reason — you're taking longer to pay the loan back.

So, let's say when you bought your car you got an 84-month (seven-year) loan, but now you're making more money. You can refinance and shorten the term, which would increase the monthly payments, but would reduce the total amount of interest you pay. Plus, you could potentially pay your car off faster.

On the flip side, say you got a 48-month (four-year) loan with payments that are now higher than you can comfortably afford. You could refinance your loan and get a longer term — 72 or 84 months — which would lower your monthly payment. While this may increase the amount of interest you pay over the life of the loan, it may also make your journey to paying off your car loan less stressful.

3. When your credit score has improved

Your credit score affects the interest rate of any loan you take on. Generally, the higher your credit score, the lower your interest rate. Conversely, a lower score will likely cause you to pay a higher rate. As mentioned previously, a higher interest rate will typically result in a higher payment and increase the total amount you pay for your car.

If you purchased your car when you had a lower credit score and you've been able to improve your score, it could make sense to see if you can get a lower rate. As always, you'll need to do the math to see how much the new rate will affect your monthly payment and total cost of your vehicle.

4. You didn't get the best deal when you bought the car

If you fell in love with your car and agreed to a not-so-favorable loan in order to get behind the wheel, you're not alone. Car buying can be emotional and often even impulsive. However, you can refinance your loan and try to get more favorable terms. You may not want to do that immediately after you buy in order to allow time for your credit to rebound, but six to 12 months later could be a reasonable timeframe to explore other options.

When you shouldn't refinance your car loan

Refinancing can help you get a payment and loan that better fits your current financial situation or long-term goals. However, there are some cases when refinancing could be a costly decision.

For example, if your loan has a prepayment penalty, you will incur fees if you pay your loan off early. These fees can easily outweigh any savings from refinancing.

Likewise, if your car is more than 10 years old and has high mileage, you'll want to assess if your car will last as long as your loan. Also, if you plan to apply for other loans in the near future — such as a mortgage — you might want to hold off so a new auto loan doesn't negatively impact your credit.

Always run the numbers

Any type of refinancing should be done strategically and thoughtfully, as it could affect your finances for years to come. Taking the time to do your research and run the numbers can help ensure you make the best possible financial decision.

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