by
financial planning
9.1.23

How, Why, & When to Refinance an Auto Loan

Refinancing an auto loan can be a great way to lower your interest rate and a monthly payment, helping you save money for other exciting things in life. Read all about what goes into a vehicle refinance to determine if it’s the right financial move for you.

Living in a state like Arizona, things are very spaced out. We don’t have the same metropolis feel of Manhattan or San Francisco where it can often be easier to hop the trolly or subway turnstiles than to chauffer yourself around the avenues. Even in our largest cities, having access to your own vehicle is not only preferred, but practically a necessity. There’s a lot that goes into having a vehicle, but it usually starts with an auto loan.

Reminisce back to the time when you were finally able to buy your first car, maybe after working one or two jobs and skipping beach trips in order to save up for one. It was pure bliss riding off the lot into the sunset like in some old movie end scene. Then the first bill came, and you were reminded of just how much that bliss would be costing you every month for the next few years. It’s a common slap back to reality for a lot of people, not only the kid getting their first new car.

Sometimes the need to finance a vehicle outweighs what you sign the contract for, so you apply a heavy enough tint to black it out in your mind at the time. Don’t stay in the dark of a bad auto loan or subprime lending. Refinancing your vehicle loan could be the easy street you’re looking for to save money and get back on the right financial path.

UNDERSTANDING AUTO REFINANCING

Refinancing auto loans simply means taking out a car loan to pay off your current car loan. It may seem strange because on the surface it sounds like all you’re doing is shifting the debt from one loan to another. However, there are few reasons people choose to refinance a car loan that can help them better their financial situation.

Reason 1 – Lower the Interest Rate, Increase Your Savings

Sometimes life decides for you whether or not you need to buy a new car, and it may happen before your credit is in the best place. If you have a low credit score at the time of getting a car loan, chances are high that you’re going to get told interest rates that hurt a little to think about. After 6 months to a year of on-time payments, you could potentially get a car loan at a much lower interest rate. Given the current state of gas prices, you need all the savings you can get.

Reason 2 – Lower Your Monthly Payment, Increase Your Monthly Cash Flow

Not everyone’s income increases as quickly as inflation, and sometimes a monthly payment that made sense when you first got your auto loan, can become unbearable to scrounge up for every month. When you refinance an auto loan, you may be able to extend the loan term or reduce the interest enough to where your monthly payment becomes a little more comfortable and a little less soul-crushing. This is also a reminder to try negotiating a higher pay rate for yourself.

Reason 3 – Change Your Loan Term, Change Your Life

When you originally got approved for financing on your existing loan, it may have made sense to stretch out your payment over an 84-month period, but now things have changed, and you can afford to pay a little more each month. Shorter loan terms often mean a higher monthly payment but a big savings on interest in the long run. On the flipside, if your income has been reduced or you’ve had to take on more debt for something else like a home or a new kid, stretching your auto loan from 36 months to 48 or 60 months could give you some breathing room to make sure all your bills are covered while still having money left over for you to afford to eat.

Reason 4 – Take Cash Back, Take Advantage of Car Ownership

It’s common to hear that vehicles aren’t good investments and that they lose value the moment you put the pedal to the metal. This is because cars don’t age like a fine wine. They only get worse with time. That doesn’t mean car ownership doesn’t have some financial advantages. When you own a vehicle, you own the equity (or worth) of the vehicle. If you currently owe less on the loan than the value of the car, you could potentially take cash out against the equity of your vehicle.

You may be asking yourself why would I want to take out MORE debt on my car loan? That is a super fair question. Answer: Auto loans typically have lower interest rates than personal loans or credit cards, so if there’s something you’re looking to finance like a new refrigerator or a vacation, using the equity from your car could be a great alternative to those high-interest options!

SHOULD I REFINANCE MY EXISTING LOAN?

Now that we’ve talked about the most common reasons to refinance auto loans, let’s try to narrow down whether or not auto refinancing is right for you.

Check the Fees

When you refinance a vehicle, there may be certain fees involved. If you would end up paying more in fees than you would save by refinancing, this isn’t a good fit. When you’re considering a new loan, always ask your current lender if they charge a prepayment penalties for paying off the loan early. Prepayment penalties are becoming less common but they still happen and steps should be taken to avoid them.

You’ll also want to look at if the new lender charges any exorbitant registration and title filing fees or application fees. Lastly, if you owe more on your current auto loan than your car is worth, you may be required to make an upfront cash payment in order to refinance. Some lenders will approve car loans for more than the value, but those amounts can vary based on factors like loan term, your credit score, age of the vehicle, and more.

Check Your Remaining Loan Term

If your current auto loan is almost paid off, don’t stretch out the monthly payments unless you’ll see a significant drop in interest. Sure, you may have a lower monthly payment, but you’ll pay more to interest in the long run. That’s money that could go toward a down payment for your next car, or a house, or a spontaneous flight to Hawaii!

A good rule of thumb is to do the math. Look at your last loan payment to see how much interest you paid and multiply it by 12. (This will be a high estimate since the amount of interest is based off of your total balance and decreases a little each month.)

Once you’ve identified how much interest you might pay in a year on your current loan, look at how much you would pay in a year with an auto loan refinance. If the new loan term is going to cost you more in interest, and you can still comfortably afford your current loan payments, it will most likely make more sense to continue with your current loan.

Check Your Credit

Check your credit report and credit history. The interest rate you qualify for on a loan is almost always directly determined by your credit score. There may be other contributing factors, but credit scores are the omega of them all. If your credit score has increased since you took out your original loan, you should absolutely take a look at what kind of interest rates you could now qualify for. There’s a huge difference between what a 650 score and a 550 score will qualify you for it, and it can mean hundreds, and in some cases thousands, of dollars in savings.

Check Your Value

Your own personal value is incredibly subjective, so we’ll focus solely on vehicle value here. It’s important to know what your vehicle is worth when you’re considering auto loan refinancing, because if you owe a lot more than the current market value, you could be required to put cash down or be declined entirely.

This is what we call “negative equity.” Negative equity is when you owe more than something is worth. This is important because lenders look heavily at a ratio called loan-to-value when decisioning loans. The higher your new loan amount is in relation to the vehicle value, the riskier your loan is going to be considered. The riskier your loan looks, the higher probability you have of getting a high interest rate or having your loan declined.

HOW TO REFINANCE A CAR LOAN IN 3 STEPS

Now that you’ve decided whether or not refinancing your auto loan is the right financial move for you, you’ll need to know how that process works and what you need to do.

#1 Prepare

Get to know your existing auto loan. Identify your current interest rate, term, and balance, and request a 10-day payoff that includes the per diem. “Per diem” is a fancy Latin term that means daily or, in this case, “daily interest”.

Get to know the market. Search out the lowest auto loan rates. Look at the interest rates of both banks and credit unions, as well as online offers and potential rate discounts.

Get to know your vehicle. When you apply for a new auto loan, the lender is going to ask for your VIN, current mileage, year/make/model (as well as any options or upgrades to your vehicle), and a copy of your registration.

Get to know your income. One of the first things a lender needs to know is that you can afford the loan payments. You’ll want to have your pay rate handy, and it never hurts to have a copy of your most recent paystub.

#2 Apply

Compare terms. Sometimes a higher interest rate + lower monthly payments fits your budget better than the reverse of a lower interest rate + higher monthly payments. Ask your loan officer for a quote on the different terms and rates. The goal should always be to pay off your car loan in the shortest amount of time, but you need an interest rate that allows you to afford the monthly payment without pinching every penny. The most important factor is getting a loan terms that you can afford.

#3 Close

Ask questions and confirm terms. Your loan closing is your last chance to make sure the new auto loan is everything you want. As you look over your loan disclosures, make notes about things you don’t understand or that don’t look like what you agreed on during the application process. Don’t be afraid to ask your loan officer questions, even if means they have to make changes. That’s their job, and it has been known to save people costly issues down the road. Always, always, always, know what you’re signing for.

DON’T BE AFRAID OF CHANGE

When all is said and done, auto loan refinancing could save you a lot of money and financial headache. You don’t have to be stuck with high monthly payments or existing loan funding that just doesn’t fit your current lifestyle. Refinancing car loans is a relatively simple process once you get started, and your auto refinance lender will be there every step of the way to answer your questions and concerns. If they’re not, find one that better suits your needs!

If a vehicle refinance sounds right for you, apply now online with SunWest Credit Union. We’ll guide you through the process from start to finish.

September 1, 2023

Published by SunWest Credit Union

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