Pros and Cons to Refinancing Your Auto Loan

While the upsides of refinancing a mortgage are often obvious, many car owners with loans want to know: What are the benefits of refinancing your car? Understanding the benefits of refinancing a vehicle, and the possible drawbacks or risks, is the best way to make an informed decision.

When Changing an Auto Loan Is Beneficial

There are several circumstances that can make it beneficial to refinance your auto loan.

  • Interest rates for car financing have fallen and are lower than what the borrower already has.
  • The borrower did not shop carefully when purchasing the vehicle and paid too high a rate.
  • The buyer's credit rating has improved and he or she now qualifies for a lower rate.

Lower Interest Rates

Interest rates for automotive financing have dropped steadily over the years, as is illustrated in the table below.

auto loan rates trend

In addition, auto finance rates have been fairly volatile and have risen and fallen many times in the last 12 months or so. The charts below show how average rates from LendingTree auto lenders have risen and fallen in the last year, and how they vary even more from day to day. This means that with good timing, a borrower could take advantage of a temporary drop in rates and grab a better deal.

2014 average auto loan rates

daily average auto loan rates

Smarter Shopping

Studies have shown that the majority of car buyers spend a lot more time shopping for the best price on their vehicles than they do looking for the lowest rate on their car loans. While consumer surveys by JD Power indicate that the average buyer spends 19 hours researching an auto purchase, the nonprofit Center for Responsible Lending reports that 80 percent of buyers simply take whatever financing they're offered by dealerships.

How much more could they end up paying? Quite a bit -- the average markup on dealership financing is nearly 2.5 percent. Paying 12.5 percent when a buyer qualified for a ten percent rate with a $25,000 car loan over five years is like paying $1,500 too much for the car. Anyone who has financed a car through the dealer should check current rates online and see if they qualify for a better deal.

Car owners who have improved their poor credit since taking out their car loans could realize a substantial reduction in monthly payments and the total cost of the vehicle.

Potential Drawbacks or Risks When Refinancing

Car owners should check the details of their current auto loans. Are there any penalties that would be applied if they refinance? Some lenders impose a prepayment penalty if a loan is paid off early, which could wipe out the savings created by the refinance.

In addition, refinancing may stretch out the repayment period to the point that the loan term exceeds the useful life of the car, or the extra years could increase the amount of interest paid over the life of the loan. This can be prevented by refinancing to a shorter term.

Avoid Title Loans

An auto loan and a title loan are not the same thing. Title loans are very similar to payday loans. The borrower receives a sum of money based on the value of his or her vehicle, and there are often no credit checks or income verification.

Title loans have very short terms and the interest rates are very high. This type of easy money loan is not designed as a refinancing tool and costs much more than a standard auto loan.

How to Decide if an Auto Refinance is a Good Choice

There are two primary answers to the question,"What are the benefits of refinancing your car?" They are:

  • Lowering the monthly payment to make the car more affordable
  • Lowering the total amount of interest paid, usually by shortening the term of the loan

The best refinances accomplish both of these goals. Generally, interest rates for loans with shorter terms are lower, so it may be possible for a car owner to reduce the repayment time while lowering the monthly payment. Borrowers should understand that lengthening the repayment time can increase the interest paid over the life of the loan, even if the refinancing lowers the interest rate.

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