Though most car loans are termed in number of months (24, 48, 60, even as high as 84 months – that’s 7 years!), that time frame is not etched in stone. Along the way, you may happen upon a reason that makes refinancing – closing out your original loan in exchange for a new loan on the same vehicle – appealing. Depending on your circumstances and reasons, refinancing can be a helpful financial tool or a method to extend and/or increase your debt to unnecessary extremes.
The Why
When evaluating whether to refinance, its important to first identify why you want to do so. The most common reasons for refinancing include:
- Decreasing your loan’s interest rate
Perhaps interest rates have declined since you first obtained your loan. Maybe your credit score has increased, allowing you to qualify for a lesser rate. Either way, getting out of a higher-rate loan in exchange for a lower rate is a great thing: It means you pay less to the lender for borrowing the money and, over time, that might mean hundreds, even thousands, of dollars left in your pocket. If your main goal is to lower the interest rate, stay focused on that. It may be attractive to go for a renewed and/or longer term to reduce your monthly payment but that would lead to you paying more interest over the extended term, defeating your primary purpose.
- Decreasing your loan’s monthly payment
Depending on the details of your vehicle and current loan, it may be possible to replace your current loan with a new and/or longer term. Spreading out the cost of your vehicle over a longer amount of time means lower monthly payments. This may allow you to redistribute your cash to other needs that may have arisen. On the flip side, this may greatly increase the amount of money you pay in interest over the life of the loan and keep you in auto loan debt for a longer amount of time.
- Obtaining cash out against the value of your vehicle
If your vehicle holds significant value – and is within a lender’s parameters – it may be possible to refinance the loan and get cash in your pocket based on the value of the vehicle. This can be a risky yet interesting financial tool as, if you are not able to keep up with the payments, the vehicle may be repossessed (as is true of any auto loan) however, doing so allows you money for whatever expense you are wanting to cover at an auto loan interest rate, rather than the typically higher interest rates of a credit card or personal loan.
- Removing a co-borrower from the original loan.
Maybe you got the loan when you were younger and needed a parent or adult to sign with you. Perhaps you got the loan with a significant other who is now no longer as “significant.” For one reason or another, you may want to sever financial ties with another person and take the loan on by yourself. As you make this move, be sure you’re aware of the terms of your refinance and the effects it will have on your interest rate, monthly payment, and length of loan; then determine whether this financial separation is worth the impacts it will have on your financial picture.
The When
Typically, there is nothing within an existing loan that prevents you from refinancing at any point. That being said, be aware of prepayment penalties: these are fees that, when outlined in a signed contract, obligate you to paying monetary penalties for paying off the loan early (as a way for the lender to recoup some of the interest they would be getting were the loan to remain in place for its full term). Some lenders have prepayment penalties, others do not. Ideally, knowledge of a lender’s practices in this area would be one of many deciding factors in obtaining a loan from a specific lender in the first place.
If you have just gotten a loan on a new vehicle and find a better interest rate or relationship elsewhere, it may still be possible to qualify for a new auto loan even though it would technically be the second loan on your car. Ask the new financier/bank/credit union what the details are in their definition of a “new” car (for example, it may need to be current model year or newer and have fewer than 1,000 miles driven). If your vehicle qualifies as a new car under the lender’s loan types, you may qualify for a lower interest rate than a similarly termed “used auto” loan.
Again, there is usually not a timeframe in which refinancing your vehicle is best as the details of each auto/loan combo are unique. However, be aware that most lenders have a cut off in regard to the age of a vehicle they will finance; for some, they may only lend against a car 8 years old or newer, others may go as long as 10 years. With that, if you are hoping to refinance your somewhat older vehicle, make sure you know partner with a lender whose lending guidelines are a fit.
The How
Once you’ve determined that a refi is right for you, most lenders will require the following:
- Current insurance on any vehicle – to show that you are insurable and that the item they will be financing will be financially protected in the event of an accident.
- Pay off information – the name of the existing lender, the account number, and balance of the loan, at least. The lenders phone number may speed things along in getting a pay-off quote.
- Information and pictures of the vehicle (or the vehicle, itself) – the year, make, model, VIN, and pictures of all sides are necessary in the loan process as well as to ensure that the vehicle is in lendable condition.
- Personal documentation – a current driver’s license to indicate your legal ability to drive the vehicle, as well as recent paystubs (or tax return) to show your financial ability to pay for the loan, and potentially utility bill with your name on it to prove your address.
Depending on where you are taking out the new loan, you may be required to have an account with the institution. Requirements are often minimal but be sure you understand the terms of that component of the relationship, as well.
Final Thoughts
During certain times, specifically when lending rates are falling or are low, you may hear quite the buzz about refinancing. Refis (of many types of loans) are a tool that is available at basically all economic times; its up to you to determine whether doing a refinance is right within your financial picture. Keep in mind that whenever you are applying for a new loan, even a refi, there will be an impact to your credit score. That’s just another reason to make sure you approach a potential refi with thought and purpose.