Should I refinance my vehicle?
If you found a $100 bill on the ground, you wouldn’t ignore it. You’d snatch it up, thankful for your good fortune.
Yet every year, car and RV owners overlook the chance to quickly pocket hundreds of dollars by refinancing their vehicle loans at a lower rate.
Banks, credit unions, and other lenders compete for vehicle loans by regularly offering refinancing deals that cost you almost nothing. Some lenders even offer cash back (typically a percentage of your refinanced loan) or other incentives to sweeten the deal.
There are good reasons to refinance -– and a few good reasons to not. Here are some of the most critical considerations to help you make the right choice:
Four reasons to refinance
- Lower your monthly payment. Refinancing can reduce your monthly payment, freeing up money for other needs.
Hint: Because the majority of interest paid on a vehicle loan occurs during the first few years, the sooner you refinance your current loan at a lower rate, the more you will save on interest expense.
- Interest rates have dropped. If you’re paying 6 percent interest, and lenders are advertising rates as low as 3 percent, or half your current rate, you may be missing out on a favorable change in the economy.
“Refinancing is so simple that I’d go so far to say that if it lowers your rate, refinancing is worth doing,” says Rich Lentz, director of consumer lending at STCU, a Spokane-based credit union.
For example, a monthly payment on a $20,000, five-year car loan at 6 percent interest would be about $386. If after two years, you refinanced the remaining balance of the loan at 3 percent, your monthly payment would drop to $369, saving you a total of $614 during the next three years!
- Your credit score has improved. If you had no credit history or there were dings on your credit report when you first took out your car or RV loan, you may have been charged a higher rate. Lenders might reward you today with a lower rate if you’ve been faithfully making your payments.
Hint: To check your credit report for free, visit www.annualcreditreport.comThis link opens a third-party website that is not affiliated with STCU..
- Shorten your loan term. If you recently got a promotion or a better-paying job, you could refinance your vehicle loan to a shorter term (length of the loan) to pay off your vehicle faster. Your monthly payments might be higher, but you’ll get out of debt sooner and likely pay a bit less in interest.
Hint: Extra “principal-only payments” can also shorten your loan term. Ask your lender how to apply extra payments to the principal of your loan.
Four reasons to not refinance
- Your loan is “upside down.” Lenders may be reluctant to refinance a vehicle that’s worth less than you owe on your loan. You can get an estimate of your vehicle’s value online at NADA.comThis link opens a third-party website that is not affiliated with STCU., kbb.comThis link opens a third-party website that is not affiliated with STCU., Edmunds.comThis link opens a third-party website that is not affiliated with STCU., and others, keeping in mind that those values may be different than the ones used by your lender.
- Your vehicle is too old. Lenders may apply a higher interest rate to refinance an older vehicle, so check first to see if refinancing will be worth it.
- Your current loan has a prepayment penalty. Penalties for paying off vehicle loans are rare, but can wipe out any savings you hope to realize. Some lenders charge a refinance fee on existing loans, so check before you refinance.
- You might pay more if you extend the term of the loan. If you’re currently set to pay off your loan in 36 months, refinancing to 48 or 60 months can, in some cases, cost you more. Refinancing may lower your monthly payments, but if it requires a longer loan term, you could rack up more in total interest charges for the loan, putting greater pressure on your finances.
Hint: If you’re in danger of not making your payments and defaulting on your loan, refinancing can buy you time to get back on your feet by extending the term of the loan.
How to refinance
Refinancing is easier than when you first signed for your car loan. No appraisal will be required and there usually are little to no fees. Many lenders accept online applications.
Ask your bank or credit union about refinancing, or look for promotions in your local newspaper or bank and credit union websites. Compare rates, terms, and any special offers such as cash back on your loan.
When you refinance, the lender writes you a check to pay off your old loan at a lower rate, and you begin making payments to your new lender. Your car’s title is transferred from the old lender to the new one.
Refinancing is a great option if you are struggling to make car payments or simply wanting to reduce your cost of debt. But it’s not the only option. Here are some other strategies available to you as you manage your monthly budget:
- Pay your loan off faster, get out of debt sooner. While some people refinance to lower their monthly payments, you could save even more if you refinanced your vehicle loan, and then continue to keep paying the same higher amount each month. That would effectively shorten the term of your loan because you would be paying your loan back faster, reducing your total interest expense.
For instance, if after one year, you refinanced your $20,000, 60-month car loan from a 6 percent to 3 percent -– but kept paying the same amount each month ‑‑ you would reduce the time it took to pay off the balance of the loan from 48 months to 44 months.
- Get a home equity line of credit. If you own a home, you might be able to pay off your car loan with a home equity line of credit. A home equity line might reduce your monthly payment because it’s typically a longer-term (5- to 30-year) loan, and the interest you pay may be tax deductible (consult your tax adviser).
There are some risks to this strategy, however. Refinancing your vehicle with a home equity line secures your home as collateral against the vehicle loan, so if you stop making payments, you could risk losing your home.
- Downsize to a less expensive vehicle. There’s nothing that says you must keep your vehicle until it’s paid off. If you’re struggle each month to make payments on your vehicle loan, consider selling your vehicle and getting a lower-priced model with smaller monthly payments.
Refinancing your car or RV, or choosing another option best suited for your budget and financial plan, can save your hundreds of dollars and give you greater financial freedom. Here’s hoping refinancing can boost your fortunes soon!