Refinancing a Car: Pros and Cons

By Russ Heaps 02/20/2024 8:00am

Quick Facts About Car Refinancing

• With refinancing, a borrower might extend the loan length, which reduces the monthly payment. A lower interest rate can also contribute to reduced monthly payments.
• Carefully weigh refinancing unless the goal of refinancing is to shorten the length of a car loan, because refinancing may translate into paying more interest overall.
• Refinancing carries with it the possibility of putting the borrower underwater.

If you are dissatisfied with the terms of your current car loan, refinancing is a potential pathway to lower monthly payments, shorten the length of the loan, or address other issues. Although not as common as refinancing a home mortgage, refinancing a car loan is an accepted tool when managing a household budget. However, along with the potential benefits come potential pitfalls. Let’s weigh some of the pros and cons of auto loan refinancing, as well as consider when refinancing might be a good idea for you.

Pros

• Lower interest rate — Over time, a lower interest rate (the money a lender charges a borrower for the loan) means you will pay less for that loan. Refinancing a car loan allows a borrower with an interest rate higher than today’s rate to take advantage of that lower rate and, thus, likely save some money.
• More affordable payments — With refinancing, a borrower may be able to extend the loan length (term), which reduces the monthly payment. A lower interest rate also contributes to reduced monthly payments. 
• Shortening the term length — For whatever reason, if the current loan is for, say, seven years and you wish to reduce the term length, you can achieve that through refinancing. However, doing so may require more cash down and possibly higher monthly payments.
• Turn equity into cash — Depending on the size of the down payment, as well as the length of the current loan, at some point, the car will be worth more than the outstanding loan balance. The amount of that difference is equity. In other words, it’s the car’s cash value. If the vehicle isn’t too old, refinancing is a way to access that cash, although doing so could extend the loan term and/or increase the monthly payments.

Cons

• More interest paid overall — Unless the goal of refinancing is to shorten the length of a car loan, refinancing may translate into paying more interest overall, even if the interest rate of the new loan is lower. This could happen if another outcome of refinancing is extending the length of the loan.
• Extra fees and charges — Although a lender may be willing to refinance a car, it will probably come with some cost over and above the interest rate in the form of fees and charges. For example, they could include charges for title transfer, application fee, and origination fee.
• Potential for being underwater — Being underwater on a car loan is when the owed balance is higher than the current book (market) value of the car. In terms of financial stability, being upside down is a bad place to be. Refinancing carries with it the possibility of putting the borrower underwater.

When Might You Consider Refinancing?

• Improved credit score — A credit score is a snapshot of a borrower’s credit health at any given moment. If your credit score has improved by 100 points or more since the start date of your current car loan, investigating refinancing makes sense. You can find out everything you need to know about credit scores with our article on Credit Score for Car Buying: Terms and Tips.
• Better auto loan interest rates — Interest rates aren’t fixed. They can vary up and down over time. If they fall significantly (10% to 5%, for example), refinancing could save some money.
• Strained budget — Refinancing a car loan to reduce the monthly payment could provide some relief for a strained household budget. When faced with the possibility of a borrower defaulting on a loan, a lender may view refinancing as an acceptable remedy, even for a higher risk borrower.

When to Avoid Refinancing?

• Higher interest rates — You may not want to reconsider refinancing if today’s interest rates are measurably higher than the rate on your current car loan.
• An older car — Lenders are leery of refinancing older cars. If your car is more than 8 or 10 years old, the odds of finding a lender to refinance it will be tough.
• Current loan underwater — If you owe more on a car than its current market value, refinancing will probably multiply that difference. Moreover, the lender may well require more money down.
• Near the current loan’s term end — If you are within 12 months of paying off the loan, refinancing doesn’t make sense unless your goal is to cash out the equity.