The Top 3 Reasons You Should Refinance Your Car Loan

by Christian Hudspeth

Is your auto loan's annual percentage rate (APR) higher than 6%? Or are your monthly payments on your car more than you can handle?

Here's some good news: if you have good or excellent credit, today's historically low interest rates offer an exciting opportunity for you to refinance your auto loan at a much lower rate, which could shrink your monthly payment and save you hundreds of dollars in interest charges at the same time.

Lenders make auto loan refinancing easy (you can usually get it done in an hour or so) and typically don't charge a fee for doing it, so long as you meet a few simple requirements. While every lender has its own unique borrower preferences, the best candidates for auto loan refinancing have:

  • Good or excellent credit
  • A car that's newer than six years old, as older cars hold less collateral value
  • No "upside-down" loan situations, where you owe more than your car's worth

Assuming you meet these basic lender requirements, here are a few situations when refinancing your auto loan can help you save hundreds and free up more of your monthly income:

1. If You Didn't Shop Lenders and Settled for the Dealer's Auto Loan

Were you lulled into that convenient auto loan at the used-car dealership when you bought your car a year or two ago? If you've suddenly realized that the APR on your current auto loan isn't very good compared to the lower APR loans you could be getting from other lenders, it's time to consider refinancing.

Let's say that one year ago, you took out a five-year, $25,000 auto loan with a 7% APR (the "dealer special"!) to help purchase your car. If you were to refinance today with another lender's auto loan at 3% APR, you'd pay a whopping $1,730 less in total interest charges over the next four years and your payments would be $55 less per month ($495 per month versus $440) according to some simple car loan calculator math.

Continuing with the example from above, here's how much you could save with auto loans at different APRs:

Refinancing of a 7% APR, 60-month Auto Loan
If You Reduced Your APR to: You'd Save: Monthly Payment
7% $0 $495
6% $441 $467
5% $876 $458
4% $1,306 $449
3% $1,730 $440
2% $2,150 $432
*Assumes refinancing a 7% APR, 60-month, fixed-rate auto loan after paying on the balance for one year.

2. If You Can't Afford Your Monthly Payments Anymore

Whether you've been hit by sudden financial hardship or you've mistakenly thought you could afford the larger payments on a three-year auto loan, refinancing can allow you to extend the term on your loan so you can lower your monthly payments and keep the repo man at bay.

Let's say that one year ago you took out a three-year auto loan for $25,000 at 4% APR and you're not able to afford the $738 monthly payment anymore.

If you were to refinance the remaining $19,897 you owe on your current auto loan into a new five-year auto loan at 4% APR, you would pay more overall in interest over the life of the loan, but your payments would shrink to just $366 per month -- that's half the original payment amount!

3. If Your Credit Score Has Improved

It's not uncommon for car buyers with less-than-perfect credit scores to have to settle for auto loans with sky-high interest rates of 15% or more.

But if you've been diligently making your loan and credit card payments on time and in full over a year or two since you took out your auto loan, your credit score may have improved significantly and you could be getting a much better deal by refinancing.

To give you an idea, the table below shows how much your FICO score can affect the APR you might receive from lenders, based on data on 60-month fixed-rate auto loan for a new car from the Fair Isaac Corporation:

How Your FICO Score
Impacts Your Auto Loan's APR
FICO Score APR Monthly Payment Total Interest Paid
720-850 3.7% $457 $2,442
690-719 5.1% $473 $3,351
660-689 7.1% $496 $4,758
620-659 9.9% $530 $6,803
590-619 14.2% $585 $10,078
500-589 15.2% $598 $10,857
*Assumes a fixed-rate, 60-month loan for a new automobile Source: MyFICO.com

As you can see, even just a modest 60-point increase in your FICO score -- an improvement from 660 to 720 for example -- could cut the APR you're offered by lenders in half.

That would give you a great opportunity to refinance, lower your monthly payment, and save thousands of dollars in total interest charges over the life of the loan.

So whether you're looking to save money in interest charges, free up cash for other expenses, or both, it's hard to find a reason not to consider refinancing into an ultra-low APR auto loan. Even if your credit score is not perfect, it doesn't take much time or effort to boost your score above 740 so you can get access to auto loans with the lowest APRs on the market.

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