Refinancing a Car — How It Works and When It's a Good Idea

For anyone who has bought a car on a loan and ended up struggling to make the monthly payments, you might have heard of refinancing as a possible solution. Refinancing a car can offer other potential benefits if you have a car loan. How does refinancing a car work, and is it worth the trouble?

Refinancing is a strategy used by borrowers of all kinds — you can refinance a mortgage, refinance your student loans, or refinance your auto loan. But what does it mean to refinance a car? What are the benefits, and do they outweigh the cost or hassle of a refinance?

Put simply, refinancing a car loan means to take out a brand-new loan to replace (and pay off) the existing loan on your vehicle. The terms of the new loan should be preferable to the borrower, who needs a different loan for some reason.

Most people don't consider refinancing a car loan without good reason. The most common reasons for pursuing an auto loan refinance are:

• To get a lower interest rate
• To lower your monthly payments
• To pay off the loan quicker

First of all, you may be able to secure a lower interest rate on the loan than you originally had. Perhaps your credit score has improved since you took out the loan, which would likely result in better interest rate offers from lenders. A lower interest rate means paying less overall, and could also lower the monthly payment.

You may also be able to refinance it to get a lower monthly payment, likely through extending the loan term (and possibly also through a lower interest rate). Extending your loan term means you'll be paying it down for longer, but if you can't make the monthly payments currently, this enables you to keep the vehicle.

Another possible goal of refinancing may be to pay it off sooner. This can be accomplished by refinancing to both a shorter term and a lower interest rate, if available.

As with any financial decision, you must weigh the benefits with the downsides. Refinancing isn't the right choice for everyone, and these are some of the chief potential negative consequences:

• Paying more in interest: lengthening the loan term (to lower the payment) could negate your savings due to more interest paid over a longer term.

• Prepayment fees and other fees: some lenders charge a prepayment penalty; refinance lenders often charge fees; state fees are possible.
• Owing more than the car is worth: you could end up upside-down after refinancing to extend the term.

Are you wondering how long you should wait before refinancing your car loan? The best time to refinance a car is somewhere earlier in the loan term, when your credit score has improved.

If you're nearing the end of the vehicle's loan term, you probably won't gain much by refinancing at this point. You should also consider your credit score — if it hasn't budged upwards much since the original loan, your loan terms likely won't improve. It also may not benefit you to refinance if you've already done so multiple times, which could impact your new loan term offers.

Yes, you'll typically incur some costs when refinancing your car loan. These could include:

• prepayment penalties from your current lender
• transaction fees, possibly from both the current and new lenders
• state registration fees
• title transfer fees

Generally, to ensure refinancing a car loan will benefit you, you need a good credit score. Here's how Bankrate says credit scores affect interest rates:

• For credit scores of 601–660, average rates are 7.25 percent for new cars and 9.81 percent for used cars
• For credit scores of 661–780, average rates are 4.90 percent for new cars and 5.47 percent for used cars

Refinancing a car loan can be helpful to borrowers in some situations. If your credit score has improved and you want to seek a lower interest rate, that can save you money. It can also help you keep your car if you need a lower payment. But be sure to run calculations comparing your potential savings to the fees and costs associated with refinancing.