When you refinance a car, you replace your current car loan with a new loan with different terms. In practice, car refinancing involves paying off your current car loan with a new one, usually from a new lender. This process can have different consequences for car owners.
Most people refinance their cars to save money, but this goal can take several forms. For example, some people refinance to lower their monthly car payments, others want to lower their interest rates or adjust the term of their loan. And still others have more personal reasons for refinancing, such as cutting co-signers from their loan. No matter what your goal is for refinancing your car, it’s important that you understand the possible outcomes. If you want to know when it might make sense to think about refinancing your car, this article may be helpful: When can I refinance my car loan?
Possible outcomes when refinancing your car
Not all auto loan refinance deals are created equal, but customers who choose to refinance often have one of the following goals in mind (this list is not exhaustive):
Lower your monthly car payments
In most cases, people look to refinance a car loan to lower their monthly payments. This priority is understandable since monthly payments on a car loan can have a direct impact on a household’s monthly finances. However, your monthly payment shouldn’t be the only consideration when refinancing…
There are two ways to lower your monthly car loan payments: you can get a lower interest rate, you can extend the loan term, or both. The best way to dramatically reduce your car loan payments is usually to extend the number of months over which you pay for your car. However, extending the loan term may mean that you end up paying more for your car overall than if you did so without extending it. However, if your lender allows you to extend your loan term and give you a lower interest rate, you can benefit by both lowering your monthly payments and paying less for your car overall. The following example illustrates how this result can occur.
Lower your interest rate and/or reduce your interest costs
While this is related to the goal of lowering monthly payments, some refinance customers value lowering the interest rates on their loans. If you improve your creditworthiness in the eyes of lenders as you pay off your car loan (sometimes they rate you based on the “Four C’s of Credit”), you can usually get a new loan with a lower interest rate. Lowering your interest rate may reduce the total interest you pay on your car loan – assuming the term of your car loan isn’t extended, or isn’t extended by too many months.
Change the term of your car loan
Sometimes refinance customers seek refinancing to change the length of their loan terms. However, this goal is typically more about reducing monthly payments rather than changing the number of months a customer pays for their car.
Remove or add someone as a cosigner on your loan
For various personal reasons, car borrowers sometimes want to refinance to remove or add someone to their car loan. Refinancing is an easy way to do this because the refinancing process gives you a new loan with a new contract.
Example: refinancing a car loan
As an example, let’s say you bought a car for $20,000 a year ago. A lender has loaned you this amount at a 6% interest rate (APR), which must be repaid over 48 months. Now, 12 months later, you decide to refinance because you want to reduce your monthly payments. So you contact a new lender who will pay off your old lender and give you a new loan. This new lender offers you this loan at an interest rate of 3% (APR) with a loan term of 48 months. By refinancing with this new loan term, you will effectively be paying for this car for a total of 60 months (with the new 48 month loan term added to the year (12 months) you paid off with the old lender).
What financial impact would a car refinance have on how much you pay for your car? For simplicity, in this example we’ll assume that you won’t pay any fees to refinance and won’t purchase any service protection products with your new loan (note that refinancing almost always involves fees and many refinance customers choose to purchase service protection products). After the 12thTh If you pay off your old car loan, you’ll still owe the original lender $15,440. Your new lender will loan you this amount by paying your old lender the $15,440 you still owe. Now your first payment on the newly refinanced loan will be made on the 13thTh month of your old loan.
The monthly payments on your new loan would be $341.75, compared to the $469.70 per month you paid on the original loan, and at the end of your loan you would pay $22,040 with refinancing after the first 12 months ($22,040 = $469.70 * 12 + $341.75 * 48).
Without refinancing after 12 months, you would pay $505 more on your loan, which would ultimately cost you $22,546 on your loan ($22,545 = $469.70 * 48). If you want to learn more about how the numbers in this article are calculated, check out this article on how car loan interest rates work.
The graphic below shows how you would repay your car loan(s) with and without refinancing in this example.
Note that the car loan balance with a refinancing line (in orange) decreases more slowly over the life of the loan than the car loan balance without a refinancing line (in blue). In this example, because you’ve extended the term of your loan, you’ll pay less principal each month and have more time to accumulate interest expense. This means you will pay off your loan more slowly than before you refinanced. However, at 3%, your new interest rate is significantly lower than your old interest rate and you will end up paying less cumulative interest charges than if you had not refinanced.
Please note that you should always make your car loan payments as scheduled, even if you are in the middle of the refinance process. Additionally, in this example, the fact that you make your last payment on your old loan in the 12th month and the first payment on your new loan the next month does not mean that the car loan refinance process can always be completed in the time between car loan payments.
While the example above shows how refinancing can benefit a borrower, keep in mind that refinancing can have various impacts on a person’s finances. If you decide to refinance, you may or may not change the term of your loan, and your interest rate won’t necessarily change — although in most cases it will. Ultimately, every car refinance is different and every refinance customer has personal reasons for refinancing. For this reason, you can benefit greatly from working with a car loan company that takes the time to learn your needs and matches you with a car loan that meets those needs.
