When you refinance your auto loan, you pay off your current debt with a new one. While it may sound counterintuitive, you should consider doing this if it can save you money in the long term. If the market rates for loans are more favorable or if your credit score has improved, it may be time for you to refinance your car loan.
Benefits of Refinancing your Auto Loan
To begin refinancing your car loan, start with assessing your financial status. If your credit score has improved, you can get a better interest rate on your loan by refinancing. Shop around and look for a lender that can give you maximum benefits. Here are some of the benefits you should consider when taking out another loan:
1. Lower your Interest Rate
Interest rates are affected by the market and your credit score. The market is always changing. If you find that interest rates have gone down a year after you availed of your loan, it might be a good time to refinance. It doesn’t have to be a dramatic drop, either. A reduction of 2% in interest rates can drastically improve your savings over the long term.
If you took out a car loan with bad credit, your interest rates must be higher than average. Your credit score should have improved over time as you pay your loan regularly. This should also give you better options and lower interest rates.
2. Lower your Monthly Payment
It is also a good time to refinance your auto loan if you need more affordable monthly payments. By refinancing with longer payment terms, you can reduce your monthly expenses. For example, you can extend your loan from 36 months to 48 months, which will significantly lower your monthly payment.
But do note the tradeoff: a longer payment term also means you might be paying more interest. It is not always the case, as you may find a deal with lower interest rates for the same duration of your current loan. If you opt for longer payment terms, the interest rates for the new loan might match your original one.
3. Pay off your Loan Faster
You might have gotten your original loan under tight economic circumstances. It led you to get loans with higher interest rates and longer payment terms. If your financial situation has improved, you might want to pay off your original loan faster. A way to do this is to get a new loan with a shorter payment term.
You would want to do this, especially if your car loan has payment terms of six or more years. While you can pay more than the minimum payments on your car, refinancing gives you options of more favorable terms over a shorter period.
4. Access more Cash using Equity
You have positive equity when your car’s resale value is worth more than your debt. You can use this positive equity to access cash by doing a cash-out refinance of your car loan.
Cash-out refinancing is borrowing more than what remains in your original loan. You get a new loan to cover your current debt, and you get to pocket some additional amount based on your car’s value. Cash-out refinancing is a good option if you need some cash on hand immediately. You might use it for side projects, to pay off other debt, or if you have an emergency.
Be aware that cash-out refinancing is only a good idea if you get a lower interest rate on your new car loan. If you do not get better payment terms, all you are doing is increasing your debt. You might want to take a personal loan instead.
Things to Watch out for
Refinancing your car loan is not always a good decision. If you end up in a worse financial position than when you started, you should not pursue refinancing.
If you’ve been paying your loans for a long time now, refinancing might not be able to save you money. You might have already paid off most of your interest, so you will not be able to reap the benefits of a lower interest rate anyway.
Refinancing might be a bad idea if your car is old or has significant mileage. It would not make financial sense to pay a debt higher than your car’s value.
Look out for prepayment penalties too. Some loans have additional fees if you pay them off early. If your original loan has precomputed interest, you will have to pay the whole interest on top of the principal. Refinancing in this situation does not make sense, as it will cost you more.
The point is to make things Better
If you’re unsure whether to refinance your car loan or not, remember that the point is to make things better. Getting a new loan to pay off your original one should put you in a better financial position. Refinancing should give you a better foothold on your debt or better control over your expenses in the short term.
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