Published April 9, 2021 | Updated March 11, 2022
Soon after the excitement of driving your new or used vehicle begins to fade, you might start dreaming about the day you no longer have to make monthly payments on it.
While refinancing your car loan soon after the purchase date won’t get you out of paying for the car, it might speed up your loan payoff and lead to substantial savings on interest over time.
Read on for insights to determine if refinancing your vehicle early is the right avenue for you.
What’s Auto Loan Refinancing?
Auto loan refinancing is when you borrow money to pay off your existing car loan and replace it with a new one. Refinancing has become a popular and fairly easy way to improve your financial situation by restructuring one of the most common types of debt.
How Soon Can You Refinance Your Car Loan?
Although you can technically refinance as soon as you find a lender willing to approve you for a new loan, the benefits really depend on timing. Let’s look at what it means to pay off your loan early, depending on how long you’ve owned your car:
60-90 Days Into Your Loan
Most credit unions and banks require the title to be in hand before they’ll refinance a car loan, so waiting a few months will give you more lenders to choose from and increase your chances of being approved. That’s because, whether you buy a new or used vehicle, it usually takes two to three months for the car title to transfer from the auto manufacturer or previous owner to your lender.
Keep in mind that your credit score will drop temporarily after you apply for your original car loan. If you try to refinance before your score rebounds, you probably won’t qualify for the rates or terms that you could get by waiting.
Six Months to a Year Into Your Loan
Holding off at least six months to refinance your car loan will allow your credit score to re adjust. This, in turn, should ensure you get a better interest rate and terms. That said, if you’re a first-time car buyer or your credit isn’t up to par, you’re better off staying in your current loan for a year. The extra months of on-time payments will allow you to boost your credit score and prove to lenders that you’re a good credit risk.
Two or More Years Left on Your Loan
Believe it or not, you can wait too long to take out a new auto loan. Some lenders require you to have two or more years left on your original loan to qualify for refinancing. Others are reluctant to refinance cars that are more than 10 years old or have over 140,000 miles.
It’s also worth noting that if you postpone refinancing for years on end, you won’t save as much in interest. Lenders typically front-load loans with interest charges, so the more months you make payments on your original loan, the more interest you’re actually paying.
Why Should You Refinance Your Car Loan Early?
If you’re thinking about refinancing your car loan when you haven’t been making payments on the vehicle for very long, it should be to do one (or more) of four things:
- Lower your interest rate
- Reduce your monthly payment
- Shorten your repayment period
- Extend your loan term
The ultimate goal should be to pay less in interest charges, and by extension, save cash over the duration of your loan.
Of course, you need to determine if any potential savings are worth your time and effort before you commit to refinancing. Use an auto refinance calculator to crunch numbers and see how different loan amounts, interest rates, and terms will affect your payments.
Advantages of Refinancing Your Car Loan Early
When conditions are right, greenlighting a refi within a year or two of when you took out your original auto loan offers a number of benefits. Here’s a snapshot.
Lower Interest Rate
If interest rates have fallen or your credit has improved since you financed your car or truck, it’s probably worth your time to at least explore refinancing. The money you stand to save by locking in a lower rate sooner rather than later could be substantial.
Smaller Monthly Payments
There are two ways you can reduce your monthly car payment when refinancing: get a better interest rate or extend the length of the loan. If you can make the numbers work, the first option is far and away the best because you’ll save money both in the short and long term.
Faster Loan Payoff
Depending on the amount you still owe on your vehicle and the interest rate you’re able to secure, refinancing to a shorter-term loan can either raise or lower your monthly payment. One thing that’s certain, however, is that you’ll pay less interest charges over the life of the loan.
Improved Financial Situation
Although refinancing to a longer-term car loan is less ideal than shortening your term length, it makes sense if you can’t afford your current monthly payments. You’ll pay more in interest in the long run, but it’s better than defaulting on your loan.
Disadvantages of Refinancing Your Car Loan Early
Refinancing your car loan isn’t without its potential bumps in the road. Here are several hazards to watch for and avoid.
Prepayment Penalties and Fees
If you’re thinking about refinancing, first confirm whether your loan carries prepayment penalties. Depending on your original lender, you may be charged a prepayment penalty if you refinance because you’re technically paying off your original car loan before its term ends.
The additional charge could potentially cost more than the amount you stand to save with a new loan, or they may be worth it in the end, but you don’t want to get all the way through a refi application to be hit with surprise recalculation.
On top of early payment penalties, you may also have to pay lender fees, closing costs, and title transfer fees if you refinance your loan. Fortunately, these one-time add-ons typically cost less than $100 combined.
Additional Interest Charges
If you refinance to a longer-term loan in order to reduce your monthly payment, you’ll likely pay more in total interest over the life of the contract. How so? Interest accumulates over time, so adding months to the term length increases the amount you eventually shell out.
Upside Down Value
One of the biggest risks of refinancing is owing more on your vehicle than it’s worth. Known as being upside down in your loan, you’re on the hook for the full amount of your new loan until it’s paid in full — even if your car is totaled in an accident or rendered useless some other way.
This can happen if you refinance repeatedly. Since cars depreciate over time, taking out a new loan over and over may extend your financial burden to the point where your car depreciates below what you owe.
Lower Credit Score
When you apply to refinance your auto loan, it triggers a hard inquiry on your credit report, which decreases your credit score temporarily. Being late with your payment or missing one altogether because you can’t afford your new loan can do longer-term damage to your credit.
|Lowers your interest rate||May trigger prepayment penalties and fees|
|Reduces your monthly payment||Could increase overall interest charges|
|Speeds loan payoff||Might put you upside down in your loan|
|Improves your ability to make payments||Decreases your credit score temporarily|
Is Refinancing Right for You?
Just because you can speed forward with an auto loan refinance doesn’t mean you should. There are times when it makes sense to accelerate a refi and other times when you’re better off hitting the brakes.
When It Makes Sense
Generally speaking, it makes sense to shift into high gear on refinancing your auto loan when:
- Your credit score has improved, making you eligible for a better rate
- You find a lower interest rate and better terms than what you currently have
- You can afford to shorten the loan term, leading to savings over the life of the loan
- You can save more money than any potential costs you may have to refinance
- You’re struggling to make your payments and need to reduce your monthly bill
When It Doesn’t Make Sense
Even though refinancing has its upside, it may not be the best route to take if:
- You have less than a year to pay off your original loan
- Your vehicle has lost significant value over time
- You can’t get a lower interest rate than you currently have
- You owe more on your loan than the car is worth
- You’re not able to improve your financial situation in some way
Refinancing your auto loan when the time is right may help you save money in the short or long term and put you on the fast track to paying off your vehicle.
By weighing the pros and cons and taking an honest look at your personal situation, you can determine if swapping out your old auto loan with a new one will help improve your financial well-being and enhance the overall enjoyment of your ride.