In recent years, the surge in prices for both new and used vehicles has significantly increased the size of the average car loan. To adapt to this trend, auto lenders have begun offering extended loan terms, enabling consumers to secure larger loans with reduced monthly payments.
According to Experian’s State of the Automotive Finance Market, the average monthly payment for a new car was $554 in the first quarter of 2019, while the average payment for a used vehicle was $391. On average, the loan amounts reached $32,187 for new cars and $20,137 for used ones. Additionally, the typical duration for new car loans exceeded 68 months, and nearly 65 months for used cars.
While debt from a vehicle purchase can be burdensome, overextending yourself financially, whether through high borrowing amounts or lengthy repayment periods, can lead to regret over your auto loan choices. This scenario is particularly concerning if the loan carries a high-interest rate due to less-than-stellar credit at the time of application.
If you are contemplating refinancing your auto loan, it’s important to understand the potential benefits and drawbacks of this decision. Here’s what you should consider.
Advantage: Potentially Lower Monthly Payments
Refinancing your car loan might allow you to achieve a more manageable monthly payment, depending on the specifics of your original loan. This can be particularly valuable if you’re finding it difficult to meet your current payment obligations or if you wish to create more financial flexibility in your budget.
A reduced monthly payment can ease the burden of managing living costs and other financial commitments. If you intend to keep your vehicle for an extended period, extending your loan term to lower monthly payments might be a reasonable strategy. (See also: Reducing Your Car Payment May Be Simpler Than You Think)
Disadvantage: Extended Repayment Period
While a lower monthly payment can be beneficial, it’s crucial to understand that this typically means you will be making payments for a longer period. This may lead to unforeseen financial issues in the future.
This concern is amplified if you refinance a used car that is already several years old. You may end up with payments on a vehicle that ages further and incurs higher maintenance costs, leading to compounded financial strain over time—despite initial savings through refinancing.
Advantage: Opportunity for a Lower Interest Rate
Another potential upside of refinancing is the chance to secure a significantly lower interest rate. If your financial situation has improved, this could translate to substantial savings throughout the lifespan of the loan.
Consider a scenario where your current auto loan balance is $15,000 at a 19 percent APR with 48 months remaining. Over four years, you would accrue about $6,528 in interest.
However, if your credit score has risen, you might qualify for a new loan with a more advantageous rate. For instance, refinancing to a new 48-month loan at a 9 percent APR could cut your total interest payments down to just $2,917, while also decreasing your monthly payment.
Disadvantage: Possible Increased Overall Interest Costs
Before proceeding with refinancing, it’s wise to utilize an auto loan calculator to evaluate the total interest expenses involved. While a lower interest rate or payment may provide short-term relief, a longer loan duration might result in higher cumulative interest payments.
Advantage: Access Any Existing Equity
Refinancing can also allow you to access any equity you’ve built in your vehicle. This could be invaluable for covering emergencies or for consolidating debt at a lower rate.
However, bear in mind that refinancing might lead to increased interest charges over time, even if you secure a reduced rate.
Disadvantage: Associated Costs of Refinancing
Lastly, consider that refinancing your car loan usually incurs various fees, which can differ across lenders. These costs may include an application fee, origination fee, and auto lien transfer fee.
Additionally, ensure that your original loan agreement does not impose prepayment penalties that could affect the refinancing process.
Is Refinancing Your Car Loan Right for You?
The decision to refinance your car loan ultimately rests with you. Transitioning to a new loan may yield savings on interest and/or reduce your monthly payments, but it might also lead to an overall increase in interest and fees in the long run.
Before making a decision, perform the necessary calculations and compare offers from multiple lenders—ideally three or more. This will enhance your likelihood of securing a loan that improves your financial situation.
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