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Are you debating whether or not to refinance your car in today’s market?
With interest rates still relatively high, it might seem like a questionable move. As of the third quarter of 2024, the average interest rate on a 60-month new car loan from a bank was 8.4%, according to the Federal Reserve. That’s nearly 3% higher than two years earlier.
However, refinancing a car can still be beneficial for some borrowers. While the current market rates make it harder to find a better auto loan, rates vary widely between lenders and are influenced by personal factors like your credit scores and income.
Here’s a closer look at the pros and cons of refinancing a car and how to determine if one can make sense for you now.
There are many potential pros and cons to refinancing a car. The primary pros revolve around saving money, paying off your loan sooner and possibly even tapping into your car’s equity.
If you’re interested in refinancing your auto loan, shop around and collect quotes to see if you qualify for a lower interest rate. All other things equal, a lower interest rate will lower the total interest you have to pay over the life of the loan.
For example, suppose you have a 36-month auto loan with a $15,000 balance and a 10% interest rate. If you qualify for a new 36-month auto loan with a 7% interest rate, it could save you about $750 overall.
The likelihood of qualifying for a lower interest rate increases if your credit has improved or the average rates in the market have dropped since you originally bought the car.
Additionally, if you didn’t shop around before getting your first loan, doing so could help you save — even if nothing else has changed.
Along with potentially lowering your interest rate, refinancing your car loan can sometimes help lower your monthly car payment. For example, sticking with the same loan scenario above, the 3% interest rate reduction drops the monthly payment by $21, from $484 to $463.
Another way to lower your monthly payment amount during a refinance is to opt for a longer loan term. For example, if your interest rate on a new $15,000 car loan stays at 10% but you opt for a longer term of 48 months, your monthly payment would drop by $104. And it could drop even further if you get both a lower interest rate and a longer term.
However, extending your loan term will increase your overall loan cost (more on that below).
If you opt for a shorter term than you currently have, refinancing can help you pay off your car loan sooner. The shorter term will cause your payments to increase, but a decrease in your interest rate can help bring it back down a bit.
For example, suppose you have a $15,000, 36-month loan with a 10% interest rate and refinance into a 24-month loan with a 7% interest rate. Your monthly payment would increase from $484 to $672, but you’d save $1,306 overall and own your car outright a year earlier. In comparison, paying off the original loan on an expedited schedule of 24 months would cost $20 more per month and $494 more total than the new loan.
Refinancing your car may also allow you to tap into the equity you’ve built in the vehicle so far. Some lenders let you borrow more than you owe and pull out the difference in cash to use how you see fit, such as to consolidate higher-interest debt.
However, approach this option with caution, as increasing your balance will generally increase your borrowing costs. If you end up unable to make a payment, you could also lose your car.
Additionally, it puts you at a higher risk of going underwater on your loan as the car depreciates.
Now that you know the pros, here are the potential cons of refinancing a car. They range from higher costs and fees to negative equity.
One risk of refinancing is that you could end up paying more in interest than you would’ve with your original loan.
A common way this can happen is if you extend your loan term to lower your monthly payment amount. While doing so will often lower your monthly payment amount, it can increase your overall loan cost.
Keeping your existing loan could be the best option if you can’t get a lower interest rate and don’t want to increase your overall costs by extending your loan term.
Another potential drawback is that you could incur costs beyond interest. Lenders and your state government may charge fees or penalties, such as:
Check for fees and penalties when researching your refinance options and factor them into the equation when deciding if it’s worth it.
You’ll also want to consider the risk of owing more than your car is worth, also known as going underwater on the loan or having negative equity. This may happen if you extend your loan term or cash out equity.
Negative equity may not be a big issue if you plan to keep the car long term. However, it can be problematic if you sell the car because you’ll have to pay the difference between the outstanding loan balance and the selling price.
It could also be a problem if the car is totaled in an accident because the settlement check won’t cover the loan balance unless you add Guaranteed Asset Protection (GAP) insurance to your new car loan.
It may still be possible to trade in a car with negative equity, but the lender will add the remaining balance to your new loan. That can put you in a deeper hole. This is an especially slippery slope if you’re buying a new vehicle, which will depreciate quickly.
You may wonder if it’s OK to refinance your car if you have bad credit, when rates are high or in another specific scenario. The best way to find out is to get quotes and run the numbers.
That said, refinancing a car tends to be beneficial in the following situations:
On the other hand, refinancing may not be the best choice in the following situations:
If you’re interested in refinancing your car loan, start by checking your credit. See where your credit scores sit and whether they’ve improved or declined since you got the first car loan. Additionally, check your credit reports to ensure everything is accurate and up to date.
From there, review your current auto loan and take note of the following:
With that information in hand, shop around and collect quotes from other lenders. Compare the new loan estimates to your current loan to see if any offers justify a refinance.
If a switch makes sense, you can move forward with the full auto refinancing process, which involves formally applying, signing the loan contract, paying off your old loan and starting payments on your new one.
Tip: Our auto refinancing calculator can help you figure out the total interest costs of auto loans and compare them side by side.
Auto Loan Comparison Example
The following frequently asked questions can help you better understand the pros and cons of refinancing your car.
Auto loan refinancing can cause your credit scores to temporarily dip due to the hard credit inquiry during the application process, the new account on your credit report and a decrease in your average credit account age. However, multiple hard credit inquiries for auto loans typically count as a single inquiry when they happen within a short time frame — often between 14 and 45 days, depending on the credit scoring model. Credit scores should return to normal following a few months of on-time payments toward your new loan.
There’s no set amount of time you should wait to refinance a car, as it varies by situation. However, if your credit dips after getting the initial car loan, it can be beneficial to wait for your credit scores to recover to improve the possibility of getting better interest rates.
Sticking with your current lender means you won’t have to sign a new loan contract, worry about paying off your old loan or create a user account in a new lender’s system. It can also benefit your credit as your average account age won’t drop due to a new account or hard credit inquiries.
Explore ways to pay off your car loan faster, save on interest, and reduce financial stress with strategies that help eliminate debt quicker.
