After a house and a college education, a car might be the most expensive purchase many of us will ever make. If you can refinance your home mortgage, why not refi your car loan?
Indeed, many lenders will let you do just that. Bank of America, for instance, says you may qualify for a refi loan if you owe at least $7,500 on your car loan, your car is less than 10 years old, has traveled fewer than 125,000 miles, doesn’t carry a salvage title, and isn’t a lemon-law buyback.
Why pay off one loan by taking out another? Because obtaining a lower interest rate reduces the cost of financing your car. The savings can be substantial. Assume you have a $25,000, six-year loan with a 7 percent interest rate. After one year, refinancing the balance to a five-year, 3 percent loan would save you more than $2,300 in total finance charges.
And now is a good time to refi, because interest rates plunged after the 2020 pandemic. The Federal Reserve set its benchmark interest rate at essentially zero, which sent consumer-loan interest rates lower. In March 2021, bankrate.com showed auto-refi rates as low as 2.7 percent on a five-year loan.
You also might qualify for a lower-interest-rate loan if your financial situation has improved since you obtained your existing car loan. With a higher credit score—say, because you’ve paid all your bills on time or you’ve reduced your overall debt—lenders may now be willing to offer you a loan with a better rate.
But there’s another reason to refi your car loan: Your monthly car-loan payments may have become burdensome, a common occurrence during the pandemic, when many people saw their incomes cut. To substantially reduce your monthly payment, you’ll likely have to refi with a longer loan—and the longer the loan, the more interest you’ll pay over its life. Still, a payment you can handle is better than losing your car to a repo man.
If you’re thinking about refinancing your car loan, there are a few caveats to be aware of:
The terms of your current loan may require a substantial prepayment penalty that would negate savings from a new, lower-interest-rate loan. The same goes if a new lender tacks on high fees to obtain a refi loan.
Most of a monthly payment goes toward interest rather than principal in a loan’s early years. And that’s when you’ll benefit the most from a loan with a lower interest rate.
If your car’s value is less than what you owe on your current loan, it may be difficult to refi the loan.
When homeowners refinance, some take a cash-out loan that puts cash in their pocket in addition to paying off their existing loan. But beware: Houses often appreciate over time; cars almost never do. It’s risky to take a cash-out loan on a depreciating asset, which only adds to your debt.
Bank of America, LendingClub, and other lenders offer online refinance calculators. Obtain rate quotes and crunch the numbers to see if you might benefit from a refi auto loan.