Should You Refinance Your Auto Loan?
Society does a great job making most people feel like they can afford a car. And for the most part, it’s FAKE NEWS!
If you can’t pay for a car in cash, you can’t afford it, yet the majority of us will finance the car because the banks will make it work for us.
And for those of us who live in the states, a study shows that 80% of Americans are in debt.
This is the time you should ask yourself “Is refinancing a car a good idea?”
Banks offer an incredible amount of money for auto loans knowing some people will struggle to make payments. However, that doesn’t change the fact that people will go ahead and finance a vehicle for sometimes astronomical amounts.
You might be asking yourself “is refinancing a car worth it?” Even though I hate answers like this… the truth is, it depends.
Like most Americans, I was brainwashed into thinking that being in debt is normal.
I purchased my vehicle in 2016 and couldn’t pay in cash, so I took out an auto loan and financed it.
The thing that keeps me on track with my finances is my Annual Budget. My budget strategy has helped tremendously and allows me to see how long it will take me to pay off and how much I’d pay in total.
After realizing how much I really have saved or would have saved at the end of the year, I decided to reallocate those savings to paying off debt.
Why pay interest if you don’t have to?!
I was still paying on my auto loan, so I kept asking myself, ‘Should I refinance my car?”
After over-analyzing like I always tend to do, the answer was clear. It made sense for me to refinance, so I did just that.
If you’re in a similar situation, you may want to consider refinancing your auto loan.
Sure, it’s completely possible that refinancing your car isn’t right for you for the time being.
But there are a few reasons why you should consider the potential of refinancing your auto loan in your journey to financial freedom.
Reasons to Refinance Your Car Loan
- Your credit has improved.
- Interest rates have dropped.
- Your debt-to-income ratio is lower.
- Lowering your monthly payment.
While having a lower interest rate or a lower monthly payment by refinancing is enticing, it is important that you consider the risks involved with refinancing as well. Carefully inspect your financial situation and your current auto loan to determine whether or not refinancing makes sense for you.
These questions were are the top of my list of concerns while considering if refinancing my auto loan was a smart decision.
- What fees will I be responsible for?
- Is my loan balance higher than the value of my vehicle?
- How old is my car?
- Will refinancing my car improve my cash flow?
- Has my credit improved?
So let’s get into it this.
Your Credit Has Improved
One of the biggest pain points of getting the best interest rate is based on your credit score.
There are 3 top credit reporting agencies that you’ll want to check your scores with 1) Equifax 2) Experian, and 3) TransUnion.
Depending on your lender, they may use a different version when you complete your auto loan application.
My favorite company that offers free credit reports and scores is Credit Karma.
Credit Karma has 2 of the 3 top credit reporting agencies featured once you create an account; 1) Equifax, and 2) TransUnion.
My credit score jumped from a 715 (Good) to a 790 (Excellent) from the time I purchased my vehicle, so when weighing out the pros and cons of refinancing, the decision was clear.
The best credit score to refinance a car is when your score is in the “Excellent” Range, 720 – 850.
Nerd Wallet has an excellent article that helps explain “What Is a Credit Score, and What Are the Credit Score Ranges?”
I started on my auto loan with a credit score of 715 with 3.99% APR and a monthly payment of $400.46 to a credit score of 790 with a 2.49% APR auto loan and monthly payments of $350.30.
Unfortunately, some people get locked into unreasonable rates due to a lack of knowledge and poor credit scores. But the moment that improves, it’s best to look into refinancing high-interest car loans.
What is a ‘FICO Score’?
What score really matters is your FICO score.
There are 5 ratings you could fall into.
|<580||Poor||Your score is well below the average score of U.S. consumers and demonstrates to lenders that you are a risky borrower.|
|580-669||Fair||Your score is below the average score of U.S. consumers, though many lenders will approve loans with this score.|
|670-739||Good||Your score is near or slightly above the average of U.S. consumers, and most lenders consider this a good score.|
|740-799||Very Good||Your score is above the average of U.S. consumers and demonstrates to lenders that you are a very dependable borrower.|
|800+||Exceptional||Your score is well above the average score of U.S. consumers and clearly demonstrates to lenders that you are an exceptional borrower.|
Interest Rates Have Dropped
Interest rates fluctuate periodically based on the economy. And right NOW we’re seeing interest rates drop like flys.
Interest rates are now historically LOW!
One of the best reasons to refinance a car loan is if you have an opportunity to reduce your interest rate. If you previously had no credit or bad credit, it is worth checking into refinancing your car loan after a couple of years to see if you receive better offers. Your credit score may have improved enough to qualify you for a lower interest rate.
With a lower interest rate, you will be able to pay off your car loan faster or lower your monthly payment while paying it off at the same pace.
In either case, you’ll pay less over the life of the loan.
Your Debt-to-Income Ratio is Lower
When I first heard of debt-to-income ratio, I immediately wondered how it was calculated.
So, what is debt to income ratio exactly?
Your debt-to-income (DTI) ratio is all your monthly debt payments divided by your gross monthly income. This number is one way lenders measure your ability to manage the monthly payments to repay the money you plan to borrow.
At or below a 36% DTI is considered the ideal ratio to have. 45% is considered a maximum.
If you’ve got Students Loans in the 5-digits, this can severely impact your DTI in a negative way.
Lowering Your Monthly Payment
For many of us, ‘Life Happens’ and we have expensive unexpected responsibilities like having a baby, dentist bills, and other unexpected medical bills, or maybe even a natural disaster can put you in a situation where you’ll want or need to reduce your monthly bills and expenditures.
Refinancing your auto loan could help you to significantly reduce your monthly bill.
For instance, if you owe two more years on your current loan, it may be possible to refinance and extend the term to four years.
By adding two years onto your loan, that should substantially lower your monthly payment, depending on the interest rate you get.
Although the drawback is you would be paying for two additional years, you’d free up more cash on hand monthly to boost your savings and other personal/household needs.
If you can, it’s smart to pay a little more on your monthly (if you can) to pay more on the principle and less in interest.
Shop Around For The Best Deal
Once you’ve done some research and decided that refinancing your vehicle makes sense, you’ll want to make sure you are getting the best deal.
Credit Unions tend to typically have some of the best rates. I used the same credit union I used to take out my auto loan initially.
I shopped around for the best rates to refinance, and my credit union still beat competitive rates in the area.
However, make sure you compare interest rates from multiple lenders and don’t forget to look out for any fees that may be added on to your new loan as well.
Whenever you’re ready to start rate shopping, try to limit your credit applications to a 14-day window. If a broker tells you, you have a larger window, and it’s OK to run another report on your credit, they’re probably lying.
Trust your gut in those situations, because YOU will be the one that’s impacted when it’s regarding your credit, not the broker.
Credit checks (also called credit inquiries) can potentially lower your credit scores. But if you make sure any credit inquiries all occur within that 14-day window, they’re combined together. These combined inquiries should only impact your credit scores (VantageScore or FICO) once.
When you refinance, the goal is to save as much money as possible. Make sure you set aside enough time to do your research and make sure you’re getting the best deal available.
Determine if auto refinancing makes sense for you
Sometimes, extending the length of your car loan can lead to paying more — NOT LESS — on your auto loan. While lowering your monthly payment can improve your monthly cash flow, that doesn’t mean it will help you save money in the long run.
Depending on what you want to do – pay off your loan faster or decrease your monthly expenses – you can end up paying way more for your car than if you had continued with your original loan.
Refinancing isn’t always free.
Most of the time, you can refinance your auto loan without incurring any additional fees for doing so. Sometimes, depending on the lender, there is a cost of refinancing your auto loan. Still, you should always inquire about fees or charges with your chosen lender before you pull the trigger.
I remember I saw a figure on my refinance loan documents and called to speak with the credit union just so I completely understood what certain terms meant and why the figures were different than what I expected.
To benefit as much as possible from your refinance, opt for a new loan with a lower rate and an equivalent or shorter repayment timeline. That way, you’ll get the benefit of a lower rate without paying on your car loan longer.
It may also be good to speak with your loan officer in person to feel more comfortable asking questions about the terms of the loan.
If you need to extend the length of your loan to qualify for some reason, you can continue paying the same amount you paid before with the peace of mind that you could make a smaller payment one month if money gets tight.
When is the best time to refinance a car loan?
The best time to refinance a car loan is right now! – If it makes sense for you.
Interest rates are incredibly low right now, and you don’t want to miss this wave.
Are you going to refinance your auto loan?
Let me know in the comment section below, I’d love to hear how much you’re saving!
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