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Why Refinance a Car? 4 Reasons to Refinance

Why Refinance a Car? 4 Reasons to Refinance
Austin Kilham
Austin KilhamUpdated September 20, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Refinancing your auto loan is an opportunity to lower your interest rate, shorten or lengthen your term, change your monthly payment, and more. Refinancing may be able to help you save money, manage your monthly payment, or pay your loan off earlier. Here’s a look at how auto loan refinancing works, the benefits of refinancing your auto loan, and reasons to refinance your car. 

How Does Refinancing a Car Work?

When you refinance your car, you take out a new auto loan and use it to pay off your old loan. You will then make monthly payments on the new loan until it is paid off.Ideally, this new loan will include some benefit for you, either a lower interest rate or a monthly payment that works better for your financial situation. 

Benefits of Refinancing Your Car

Refinancing your car loan can provide a variety of benefits that may help improve your financial situation. Here’s a look at the most common reasons as to why you would refinance a car. 

Lower Interest Rates

Interest is the amount of money you pay your lender to borrow money. When you first take out an auto loan, you agree to an interest rate. But you’re not necessarily stuck with it. You may be able to lower your interest rate when you refinance, which can save you money in the long run assuming you keep your term length the same or shorten it. You may typically qualify for a lower interest rate in one of two ways. First, lenders set interest rates based in part on the federal funds rate. When the Federal Research lowers interest rates, lenders may do the same, providing an opportunity for borrowers to lower their rates. Additionally, when borrowers build their credit score, they may qualify for a lower interest rate. A refinancing calculator can help you examine your rates and gain an understanding of how much you might save when you refinance. 

Pay Off Loan Faster

When you refinance your auto loan, you have the opportunity to change your loan term. This is the agreed upon amount of time over which you’re required to make monthly payments until your loan is paid off. When you decrease your loan term, you’ll pay off your loan faster. Your monthly payment will increase, but lenders frequently view shorter loan terms as less risky and may offer you a lower interest rate in exchange. 

Lower Monthly Payments

You can also lengthen your loan term when you refinance. When you do so, you’ll be decreasing your monthly payment. However, by lengthening your term you’ll also be increasing the amount of time that you’ll need to make interest payments, which can end up costing you more in the long term. 

Risks of Refinancing

Before refinancing, there are some important potential disadvantages to take into consideration. 

Associated Fees

There are costs associated with refinancing a car. Your lender may charge application fees to refinance your vehicle. Also, look into whether your initial auto loan charges early payment penalties. When you repay your loan early, lenders miss out on potential revenue from interest. They charge prepayment penalties to incentivize borrowers not to pay off loans early. If refinancing your loan triggers prepayment penalties, be sure that the cost of the penalties does not override the savings you’d garner from refinancing in the first place. Finally, there may be other costs associated with refinancing. For example, depending on where you live, you might have to pay a fee to retitle your car. 

Increased Interest

Depending on the choices you make when you refinance your car, you may end up paying more interest, namely if you increase your loan term to lower your monthly payment.Recommended: Questions to Ask When Refinancing a Car

4 Reasons to Refinance Your Car Loan

When should you refinance your auto loan? You only want to refinance your car loan when it will benefit you. The following four situations may present the right opportunity.

1. You Need to Lower Your Monthly Payments

If you find yourself in financial distress or you’re otherwise no longer able to afford your monthly payment, refinancing can be a way to free up space in your budget. Refinancing to a loan with a lower interest rate will lower your monthly payments, as will lengthening your term. Just beware that when you lengthen your term, you may end up paying more interest in the long term. That said, paying extra interest may be preferable to missing loan payments and defaulting on your loan. 

2. You Credit Score Has Gotten Better

The interest rate you qualify for is largely based on your credit score, a three digit representation of your credit history. Your credit score allows lenders to see how responsible you have been paying off your debts in the past. Lenders typically view borrowers with higher scores as less risky and will tend to offer them lower interest rates. Borrowers with lower scores, on the other hand, may qualify for loans with higher rates. If your credit score has increased since you first took out your auto loan, you may now qualify for an auto loan with a lower rate, which could save you money on interest payments over the life of the loan. Recommended: What Credit Score Do You Need to Refinance a Car?

3. You Qualify for a Better Loan Agreement

In some cases, you may not have gotten a very good deal on your original auto loan. So even if interest rates haven’t dropped or your financial situation hasn’t improved significantly, it may be worth shopping around for a loan with a better interest rate and better terms. This may be especially pertinent for borrowers who financed their car with a loan from their dealer, since dealers may offer higher interest rates than other lenders. 

4. You Want to Remove a Cosigner

If you had no credit history or a poor credit score when you took out your auto loan, you may have needed a cosigner to qualify. Cosigners agree to make loan payments if the primary borrower is unable to do so. Since then, if you have established solid credit, you may qualify for a loan on your own and can refinance the loan in your name only. Similarly, refinancing is the only way to remove a co-borrower from an auto loan. 

The Takeaway

There are many reasons you may be interested in refinancing your car, including wanting to lower your monthly payments, being able to secure a lower interest rate, or wanting to remove a cosigner from your loan.If you do decide to refinance your car, the first step is to shop multiple lenders to find the best interest rate and terms. Lantern by SoFi can help you compare loans from top lenders with just one simple application. When you find a loan that works for you, you will fill out a loan application with your name, Social Security number, proof of income, and information about your previous loan. Your lender will run a credit check and let you know if you qualify. Once you sign a loan agreement, you’ll pay off your old loan and begin making payments on your new loan.

Frequently Asked Questions

How many times can I refinance a car loan?
How soon can you refinance a car loan after purchase?
Is refinancing a car worth the effort?
Can I refinance a car with bad credit?
What questions should you ask when refinancing a car?
Photo credit: iStock/martin-dm

About the Author

Austin Kilham

Austin Kilham

Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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