5 pro tips on refinancing your car loan - and when not to do it

By Russ Heaps

There are several sensible reasons to consider refinancing a car loan. Among them are lowering the monthly payment, shortening the loan terms, and reducing the interest rate. However, is refinancing a car loan possible?

Refinancing a car loan: Is it possible?

Yes, you can refinance a car loan. Many lenders will consider refinancing your loan even if your financial situation is unchanged since you originally financed your car. However, according to Bankrate.com, many lenders won't consider refinancing a loan less than one year old. OK, we've established you can refinance, leaving the question: should you?

It's a legitimate question because of the current high refinancing interest rates for car loans, even for those with sterling credit. However, it's debatable if it's the best time to do so. Read on to learn more.

How do you refinance a car loan?

Like refinancing a home mortgage, refinancing a car loan is taking out a new loan on a vehicle you have financed. Often, the new loan will be from a new lender. Moreover, the new loan will come with new terms for the length of the loan and a different interest rate. The application process is the same as it was when securing the original financing. Depending on the lender, an owner may or may not need a car appraisal. Many lenders will use a source like Kelley Blue Book to establish a vehicle's current value. The lender may also charge some loan origination fees.

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Why refinance a car loan?

Lower interest rate - The top reason for refinancing a car loan is to lower your interest rate substantially. This is particularly true for borrowers who have faithfully made on-time monthly payments on the current loan and/or had a big boost in their credit score. The difference between 7% and 5% rates can save you hundreds of dollars over four or five years.Lower monthly payments - If a borrower's monthly budget is stretched to the max, refinancing might free up some cash each month through lower interest rates and/or longer monthly terms.Longer or shorter terms - Stretching out a car loan for a longer period can reduce the monthly payments, even if the interest rate remains the same. All things being equal, a loan of longer length will free up extra cash each month over the life of the new loan. However, the longer the loan term, the greater the total interest paid. On the other hand, refinancing can reduce the loan's length when the goal is to pay it off sooner.

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When to avoid refinancing a car loan

Higher interest rate - When a higher interest rate offsets any advantages of refinancing because of rising rates or the borrower's substantially lower credit score, it may not make sense to refinance.Upside down in the current loan - If the vehicle to be refinanced has a book value less than the outstanding balance on the existing loan, it's considered upside down. In such cases, the lender will either require an upfront payment (down payment) to cover the difference or fold the difference into the new loan. Again, the borrower must carefully consider if refinancing will provide any benefit.Credit score ding - Applying for a refinancing loan may initiate a "hard" credit check by the lender or lenders. Such hard checks are reported to national credit bureaus such as Experian, and will probably temporarily lower a borrower's credit score. This may affect a borrower's ability to secure a mortgage, credit card, or other loan for six months or longer.

5 pro tips for refinancing your vehicle loan

Know your car's value - Before mapping out where you are going, you must know where you are. Therefore, before launching on the quest to refinance your car, you need to know its current market value. That is, what it is worth. Kelley Blue Book can pinpoint your car's current market value with its valuation tool.Interest rates may be dropping - As 2023 drew to a close, we saw average interest rates for new and used car loans modestly trend downward. This is according to Kelley Blue Book parent Cox Automotive. Although a half of a percentage point lower rate alone isn't usually enough to make refinancing worthwhile, it is a sign that market conditions for refinancing are improving after many months of higher car loan interest rates.Don't dig a deeper hole - Avoid refinancing if the long-term effects will harm, rather than improve, your financial health. For example, if you currently have some equity in your car (you owe less than the car's market value), you probably shouldn't refinance if doing so leaves you upside down (you own more than the car's current value).Shop around for the best rate - Some lenders charge less for using their money than others. Moreover, different lenders will evaluate the loan risk you pose differently. Either or both of these factors mean the interest rate for which you qualify can vary by lender. Consequently, shopping around makes sense.Beware of extra charges and fees - The interest rate is the cost of the money borrowed; however, there may be other costs associated with refinancing. These are primarily administrative in nature, such as an application fee, title transfer fee, and so forth. Your current loan could even have a penalty for paying off the loan early. These added costs can add up and should be weighed against any savings refinancing might provide.

Final thoughts

For borrowers with a good credit history and a solid credit score, refinancing an auto loan is an option that makes sense if it achieves a specific goal. For example, getting a lower interest rate, reducing monthly payments, or creating a situation where the loan can be paid in full sooner are all sensible reasons for refinancing. However, due to the moving parts in any refinancing deal, take the time to do the math to determine if refinancing a car loan will achieve your intended goal.

This story originally ran on KBB.com.

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