Refinancing an auto loan may seem like a foreign idea to you. You may have been told that it is a wise financial decision, but refinancing can be a confusing process. Here is what you will need to know if you are considering refinancing an auto loan.
What is refinancing?
Refinancing is the process of paying off a loan by taking out a different loan. This allows you to take advantage of a lower interest rate on the second loan instead of keeping a higher interest rate. Here is a quick look at the pros and cons of refinancing:
- You can potentially reduce your monthly payments.
- Reducing loan interest rates reduces the total amount you will pay.
- Paying off loans increases your credit score.
- You will have to adjust to a new financial institution.
- Your eligibility relies on improvements in your credit score.
- Some loans may have a penalty and fees for early payoff.
Refinancing does have benefits, but they generally only apply if your credit has improved since the first loan. This will allow you to take advantage of lower interest rates, and therefore lowering the total cost of the loan. For example, a 5-year loan of $5,000 taken out at a 6% interest rate will cost a total of $5,799.84. The same loan taken out at a 4% interest rate will cost a total of $5,524.96.
Should I refinance?
This question is answered by simply examining your financial situation. If your credit score has improved, even by 50 points, you should be able to get a loan at a better interest rate. Additionally, refinancing can provide you with lower monthly payments. However, lower monthly payments should not be your only goal. It is still possible to gain lower monthly payments by extending the life of your loan, which results in you paying more for the loan in the long run.
Refinancing can be hugely beneficial, but sometimes it is better to keep your old loan. As mentioned previously, some loans may carry fees and penalties for paying the loan early. You can avoid these simply by not refinancing. Refinancing also means going through another loan process, which you may want to avoid. The important thing is to take a look at how much money you will save by refinancing. If you would only save $500, it may not be worth the hassle to you.
Things to Watch For
When considering refinancing, look into how much your credit score has improved. A few points won’t be worth a refinancing, but if it has increased by 50 points or more, you may be able to get better rates and make refinancing a more viable option. The other thing you will want to look into is what interest rates as a whole were like when you took the first loan. If interest rates were low at the time and higher now, it may not be financially prudent to refinance.