For most of us, a car is a necessity.
But interest rates have soared over the past few years, leaving many car shoppers stuck with larger loans and higher monthly payments. That strain on household resources has led to rising auto loan delinquencies, according to data from the Federal Reserve.
The Fed recently voted to lower interest rates -- and more cuts are on the horizon -- which could finally mean some relief for borrowers. But what if you're still paying off your current car loan? Could refinancing help you get a lower interest rate and lower monthly payments?
Maybe, but there’s a lot more to consider than just what's happening with the federal funds rate.
“Refinancing encompasses more than securing lower rates; it pertains to your financial well-being,” said Mark Hirsch, a personal injury attorney at Templer & Hirsch and the founder of Prime Time Business Network.
If your car loan payments are eating a big part of your budget, we'll help you figure out if refinancing could save you money, how to refinance your loan and what to do if refinancing isn’t an option.
When should you refinance an auto loan?
Consider these four factors when deciding whether to refinance your auto loan.
Lower interest rates
Headlines abound when the Fed lowers its target interest rate, but it’s not guaranteed to change your financial situation.
“[A lower Fed rate] can be a good trigger to look to refinance but not necessarily do a refinance,” said Chad Gammon, CFP and owner of Custom Fit Financial. “The lower Fed rate often means that auto loan interest rates will go down, but it also depends on personal matters.”
When the Federal Reserve raises or lowers interest rates, it directly affects the borrowing rates among banks. So when the Fed lowers the federal funds rate rate, banks will typically lower interest rates on consumer products like auto loans and credit cards.
If your financial circumstances are otherwise exactly the same as when you took out the loan, that could mean you’d qualify for a slightly lower interest rate than the one you have now.
Your credit score
Your credit score is likely to sway your loan's terms much more than than a single shift of the Fed's rate. If your score has gone up significantly since you borrowed the loan, you have a good chance of qualifying for a much lower interest rate.
However, if your score has gone down since you first borrowed, you’re likely to get strapped with a higher interest rate even if the Fed rate has gone down. Before refinancing, use these tips to help boost your credit score.
How much you still owe
Refinancing isn’t always the most useful move even if you can get a lower interest rate.
“Refinancing is more advantageous when your loan has a substantial remaining balance,” Hirsch said. “Lower balances may not warrant the expenses associated with refinancing.”
The savings from refinancing won’t likely be worthwhile if you’re near the end of repaying your loan, because you’ve already paid the bulk of the interest on the loan. You’ll see a greater benefit if you have several years of repayment left.
Your overall financial circumstances and goals
Your lending decisions should always take into account your full financial picture, not just one or two data points about a particular loan.
When deciding whether to refinance and what you need from a refinanced loan, consider how much you want to pay toward the loan each month and how quickly you want to have the loan paid off in addition to the interest rate. To figure out those details, look at your other monthly expenses and your short- and long-term financial goals. How any existing or new loan fits into that overall picture can help you decide whether refinancing is right for you.
How to know whether refinancing will save you money
When you’re refinancing any loan to “save money,” start by determining where you need to save: Do you need a smaller monthly payment to free up resources for other spending or saving? Or do you want to spend the least amount possible over the life of the loan?
Refinancing can help you achieve either of these goals, but usually not both. Getting a lower monthly payment will likely extend the number of months you’re repaying the loan and, therefore, usually increase how much you pay in interest and the overall cost of the loan. Getting a loan at the lowest overall cost possible will probably mean a shorter repayment term and, therefore, higher monthly payments.
A lower interest rate might reduce your costs enough to let you get a lower monthly payment and a shorter repayment term through a single refinancing, but it would have to be a substantial drop.
Use an auto loan calculator to play around with potential interest rates, monthly payments and loan terms to see what would work for you. Then you can use a loan marketplace to get a sampling of loan terms you might qualify for to see if refinancing could help you reach your goals.
Also factor in potential fees. The best auto loans don't charge fees, but some charge a small application fee or an origination fee that gets tacked onto your balance.
Other options besides refinancing if you can't afford your auto loan payment
You still have other options if refinancing isn’t for you, but you still need a lower monthly loan payment.
Hirsch recommended talking with your existing lender first. You might be able to renegotiate your loan terms without refinancing into a whole new loan. If you can extend your repayment term, you could get a lower monthly payment. This will increase the total interest you pay over the life of the loan, but it could be what you need to live within your monthly resources.
Also look at other monthly expenses you could cut to allocate more money toward your auto loan payment. By renegotiating other debts or reducing bills, you could put more money each month toward the principal of your auto loan and pay the loan down faster, Gammon suggested.
If you find yourself with a loan you just can’t afford and can’t modify, protect yourself from repossession by planning ahead:
- Try to sell the vehicle for at least as much as you owe on the loan, so you can pay the loan down to zero and eliminate your monthly payment. Look into carpooling and public transportation options in your area to modify your commuting plans if you rely on the vehicle to get to work or other destinations.
- You might also be able to trade in the vehicle for a lower-cost option that meets your needs and puts less of stress on your resources.
How to refinance your auto loan
Follow these steps to refinance your auto loan.
- Review your credit score and other financial circumstances. You can find out your credit score through a credit monitoring app, your bank or credit card issuer, or from one of the major credit bureaus.
- Enter your information in an auto loan marketplace online to see prequalified loan options. These aren’t official loan applications, and getting this information is considered a soft inquiry that won’t impact your credit score. It just gives you an idea of the kinds of loans you might qualify for based on your credit score.
- Talk to your local bank or credit union. Knowing what you can get from an online lender is a good start, but talk with a brick-and-mortar institution in your area to get more options. They can often give helpful advice and might offer more options if you have trouble qualifying for a loan.
- Use a loan repayment calculator (like this one) to see how various loan terms would fit into your financial situation.
- Choose a lender and submit a loan application. This will be your official request for a loan from a financial institution and is consider a hard inquiry, so it’ll likely show up on your credit report.
- Review any loan offer you receive; you’ll get to examine the details before you officially accept the offer. This might not match any prequalified offers you saw, so check the interest rate, repayment term and monthly payment amount carefully to make sure they fit your financial goals.
- Accept the loan offer, and receive your funds. The new lender might send money directly to your old lender to pay off your old loan balance, or it might give you the money to make a final payment to your old lender yourself. Once that’s done, you’ll only owe money to the new lender on the new terms.
You can usually receive refinancing funds immediately or within a day or two of finalizing all the lending paperwork. Your first payment to the new lender will probably be due about 30 days after that.
