Many people who own cars choose to refinance at some point. Refinancing is the act of having your car loan paid off by a second lender, and starting a new loan with that lender on new (and more favorable) terms. This is quite common for people who are looking to adjust their finance plans to find ones that better fit their needs.
That said, a car refinance isn’t always good. There can be downsides. Here are the pros and cons of refinancing your vehicle.
Pro: Lower monthly payments
The biggest upside of refinancing your car is the most common reason for why people do it: to lower their monthly payments. There are usually a few different ways that you can set up a refinancing, but the most popular is to increase the loan term (or length of the financing), and decrease the monthly payments from those of the original loan.
Let’s say, for instance, that you originally owed $20,000 over 48 months on your car. After 24 months you owe $10,000 on your current loan, and decide to refinance for 36 months. You’ll greatly lower the cost of your monthly payments by doing so, so it may be a good idea.
Con: Potential penalties
There are some financial penalties that you can pick up when refinancing your auto loan. One of them is a penalty simply for refinancing. Your current lender may prefer that you don’t refinance with a new lender, and will charge you a fee or prepayment penalty if you do so. Usually this is a few hundred dollars, but can even reach the thousands. Furthermore, there are other fees and penalties that may come with refinancing, such as a fee charged by the new lender for the application process, the cost of having the title switched, and closing fees.
Pro: Lower interest
While getting a lower payment is the most common reason for refinancing, getting a lower interest rate through auto refinancing is also a perk that many people pursue. By refinancing, you can often get a much lower interest rate, because the new lender isn’t assuming as much risk as your original lender. If your credit has improved since first purchasing the car, that will only make your interest even lower.
Con: Possibility of losing money
While a lower monthly car payment and lower interest rates are positives for refinancing, it’s not uncommon for people to lose money over the long run in the process. If everything works out right, you can save money on both monthly payments and interest, but often you’ll lose money if you’re not paying close attention.
For instance, many refinancing opportunities allow you to refinance your car for a longer period of time at a much lower monthly rate, but with a higher interest rate. This might still be the right situation for you, but it can cost you money overall in the total interest you pay.
Pro: Opportunity to gain equity
Some lenders will allow you to gain equity when refinancing a car, if you have enough paid off. Suppose your car is worth $15,000 in its current state, but you only owe $10,000 to the original lender. If you refinance, you’ll be asking for a $10,000 loan, while the lender takes over a $15,000 asset. Because the car is worth more than the loan, many lenders will be willing to lend you some of that money. So they might put $3,000 in your pocket, while you refinance for $13,000 instead of $10,000. This gives you an opportunity to gain some cash flow in the short term.
Going through the process of refinancing isn’t a ton of fun, and a lot of phone calls and paperwork are usually involved in switching from your existing loan and potentially dealing with multiple lenders. It’s not a big deal, but it is a little bit of a hassle.