Pros and cons of refinancing an auto loan

February 28, 2022

By Jamie Smith

Pros and cons of refinancing an auto loan

A woman drives in her car after she refinances her auto loan.

Car buyers will haggle over the purchase price of a vehicle without thinking about the long-term implications of a bad financing deal. Agreeing to a bad car loan can cost you dearly over time. However, if you are one of the many people stuck with a less-than-favorable car loan, you might have options. Did you know you can refinance your auto loan? Most people know about mortgage refinancing, but they don't know about the potential savings that a refinance auto loan offers. 

When should you consider refinancing an auto loan?

Every person's situation differs. What may be right for you isn't the best option for another person. That’s why you should explore your options to see your potential savings. You can calculate your monthly payment amount using our online car loan calculator to test different payment scenarios. 

If you fall under one of the following situations, you should consider auto loan refinancing options. You may be surprised by how much you can save. 

Refinance loan rates have decreased

Did you purchase your vehicle a while ago? Interest rates for auto loans fluctuate regularly based on the prime rate and several other factors. If you got your loan a year or so ago, there's a decent chance that auto loan rates have decreased. In some cases, this drop in interest could save you hundreds every month.

Your credit score has improved

What is your credit score right now? Is it higher than when you initially bought your vehicle? If so, there's a chance that your payments could drop because you now qualify for lower interest rate loans. Even if bank rates didn't decrease, it could make sense to refinance a loan if your credit score is better now. 

You received a dealer loan 

If your initial auto loan is through the vehicle dealer, you could be paying more than you would with another type of lender. Dealers typically charge more for an auto loan when compared to a bank or credit union. Don't stick with higher interest, dealer-arranged financing. 

You need to lower your monthly payments 

Who doesn't want to lower their monthly payments? Refinancing can get you a lower interest rate and lower monthly payment amount so you can put more money toward other bills you have now. 

Tips for refinancing an auto loan

If you've decided to explore refinancing options, you need to do some research. Here are some helpful tips for refinancing an auto loan. 

Check with your existing lender

Before you start looking at other lenders and options, contact your primary financial institution to discuss what refinancing options, if any, are available. Since you already have a relationship with them, this may be the easiest option. 

Shop around 

If you are looking for another financial institution, shop around before submitting applications. You should compare interest rates and offers from multiple lenders. Each one has its own way to calculate your rate, which is why it's important to compare offers. Look closely at ones with prequalification tools. This option allows you to receive a rate quote using a soft credit inquiry that doesn't impact your credit score like a full application. 

Remember to calculate fees

Before you immediately submit an application for refinancing, be sure you know all the potential fees. Does your existing auto loan have a prepayment penalty? If it does, that means paying off your loan early will require you to pay a penalty amount. You may need to do some math to figure out if the monthly savings on the new loan is worth whatever the prepayment penalty might be. When you finance an auto loan through Alliant, we don't charge any prepayment penalties. If you want to pay off your loan early, you are free to do so! 

Also, check what fees the new lender is charging. Are there processing fees or prepayment penalties on that loan? Calculate all these fees to ensure you aren't paying more in the long run. 

Verify interest rate term 

You also want to confirm the interest for your loan. Is it a fixed rate, and for how long? For example, many lenders' best rates may only be fixed for 36 months; at Alliant, our best rates are fixed for 60 months. Watch for lenders that offer really low rates that only apply to short-term loans. You might find the rate jumps dramatically after that initial term. 

Consider the impact on your credit score 

One of the reasons to look for lenders that offer prequalification tools is to reduce the potential effect on your credit score. The more applications you submit, the greater impact it might have on your credit report, depending on how many times you apply within a certain period of time. Your credit score could potentially drop a few points when you apply for an auto loan. However, most credit scoring models will lump multiple inquiries for one loan type together, provided they are made within a certain timeframe. For example, applications for an auto loan all made within 45 days will be treated as one inquiry for your FICO score. 

While these applications might temporarily lower your score a few points, what's more important is your payment history. If you have a history of on-time payments and continue to do so, that will help your score increase. 

The potential for your score to drop a couple of points when applying shouldn't be the reason you opt to skip refinancing your auto loan. Unless you have submitted numerous applications in recent weeks or lack a long credit history, refinancing an auto loan won't make a huge impact to your score. 

Mistakes to avoid when refinancing an auto loan 

Refinancing an auto loan isn't necessarily ideal for everyone. It could end up costing you more, which is why it's essential to do your research first. Timing can be an important factor in determining whether or not refinancing makes financial sense. 

Are you upside-down in your original car loan? What that means is you owe more on your loan than the vehicle is worth. Lenders are not likely to extend refinancing to someone who owes more than the vehicle's value. 

If you are far along in your original loan repayment, verify how much of your payment is going toward interest now. You may primarily pay down the principal balance, so refinancing won't benefit you if you have to start paying additional interest. Refinancing an auto loan could be more financially beneficial if you recently purchased your vehicle. 

What is the mileage on your car, and how old is it? If you have an older vehicle with high mileage, it could keep you from getting a new auto loan. Lenders are not necessarily as willing to refinance a loan on a vehicle with 100,000 or 200,000 miles, or a 10-year-old vehicle, etc. Verify the minimum requirements for the lender you are considering. 

We mentioned looking at your loan to verify whether there is a prepayment penalty. You don't want to apply for a new auto loan only to find out you owe an added amount on your original one. Your lender will typically pay off the original loan, which is why you want to verify there is no huge penalty rolled into your new payments. 

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