Is refinancing my car worth it?

Refinancing involves replacing an existing loan with a new one, typically through a different lender. Most people will use it to reduce their monthly payments by getting a lower rate or extending their loan term. But is the process worth it for you?

Auto loan refinancing is generally a good idea if it allows you to save money on interest. But it’s not always a wise financial move, especially as interest rates continue to rise, so think carefully before applying.

When should I refinance my car loan?

There is no best time to refinance your car loan — if it saves you money, it is a good time.

To illustrate, assume the remaining balance on your auto loan is $18,000, the current monthly payment is $450, and you have four years remaining on the loan term. You get approved for a four-year auto loan, but the interest rate will be 5 percent instead of the 8 percent you currently pay. Your monthly payment will drop to $414.53, and you’ll save $1,702.69 in interest over the life of the loan by refinancing.

There are a few situations where refinancing makes the most sense.

Rates have gone down

If you got your loan when average rates were high and they’ve since come down, it’s wise to look into refinancing. Unfortunately, auto rates have steadily risen throughout 2022 and into 2023. The rates to refinance tend to track with used vehicle rates, which currently sit at high levels.

The average interest rate for a used car loan with a 48-month term was 7.19 percent as of late April 2023. The average rate for the same type of loan is now 8.04 percent as of August 2023. While rates may continue to rise, you can get better rates by getting a loan with a shorter repayment term and keeping your credit score high.

Your credit score has improved

Even if market rates haven’t changed drastically, improving your credit score may be enough to get a lower rate. You may qualify for better loan terms that will reduce your monthly and overall costs. Consider how a borrower with a better credit score can secure more competitive rates based on average rates for each credit score range, according to Experian’s first-quarter 2023 data.

You received your initial loan from the dealer

Dealers tend to charge higher rates than banks and credit unions to make a profit. If you took out your initial loan through dealer-arranged financing, refinancing with a different lender could get you a lower rate.

You need lower monthly payments

In some cases, refinancing a car loan may be your ticket to a more affordable car payment, with or without a lower interest rate. If your budget is tight and you need to reduce your car payment, you could refinance your loan to a longer repayment term — but expect to pay more in interest because you are extending the loan.

When refinancing doesn’t make sense

Refinancing a car loan isn’t always the right choice. Consider the following circumstances when securing a new loan may not be the best move.

You’re close to paying off your loan

If you are nearing the end of your loan term, then the refinancing process may not save you money. Instead, you should stick with it unless you desperately need to extend your loan term to reduce your monthly payment.

In most instances, you’ll also need to have made at least six payments on the loan and have at least six months remaining on the loan term to refinance. Lenders also have minimum and maximum balance thresholds to be eligible for refinancing — typically between $3,000 and $75,000.

You owe more than the car is worth

The further you are in the loan, the more likely you owe more on the car than it is worth — a scenario most lenders will not approve. This is also called being “underwater” or upside down — and it will make it hard to refinance.

Interest rates are high

Finally, with rising interest rates, you may pay more by refinancing in the current market environment. The Federal Reserve has been working to control inflation by increasing the Federal Funds rate, which in turn causes interest rate increases on everything from credit cards to car loans. The average APR for used vehicles was 11.70 percent as of 2023’s first quarter, according to Experian.

Your car doesn’t meet lender requirements

Lenders determine eligibility differently. Before you refinance, check the requirements for you, your vehicle and your current loan. Most lenders will require:

• A regular source of income, a low debt-to-income ratio and good credit
• Proof of residence, such as a lease agreement, mortgage statement or utility bill
• Your car’s make, model, year, vehicle identification number (VIN) and mileage to evaluate your car’s worth
• Your loan’s current balance, monthly payment and payoff amount to determine if you meet its minimum loan requirements

Finally, the car should be no more than 10 years old — some lenders limit the maximum age to eight — and the mileage should not exceed 100,000 or 150,000, depending on the lender.

Fees will outweigh your savings

Before refinancing, consider whether fees will impact your overall savings. Some auto loans have a prepayment penalty in place, which means paying off your loan early can cost you more than you would save by reducing the interest rate.

Some lenders also charge a substantial origination fee when you take out a loan to refinance. Like a prepayment penalty, it can eat into the potential savings and make refinancing more of a hassle than just sticking with your current lender.

Both your old and new lender may charge transaction fees, covering administrative or processing costs for terminating the old loan and starting the new loan agreement. You may be able to negotiate these fees. Some states will charge you state registration and title transfer fees for re-registering your car following refinancing.

The bottom line

The primary reason to consider refinancing is if you can qualify for a lower rate and will save money in the long run. Consider how much longer you have on a loan before proceeding with a refinance. Your savings may not be insignificant if you’re too far into the loan.

If refinancing is too expensive, you still have options. You could be better off requesting a car loan modification with your lender if your car payments are stretching your budget too thin or you’re experiencing financial hardship.