Is Refinancing Your Auto Loan a Smart Decision?

If you have a car, there is a chance that you also have an auto loan that you must pay off. Depending on the terms of your current loan, you may be paying too much in interest each month. However, even if you do pay a relatively high interest rate, is it in your best interest to refinance your auto loan?

Can You Lower the Interest Rate?
Your payment each month consists of both a principal payment and an interest payment. The amount of interest that you pay each month depends on your credit score and other factors considered by the lenders. If you can reduce your interest rate, you can reduce your monthly payment by $50 or more per month depending on the amount of the loan and how long you have left to repay it. However, if you are unable to reduce the interest rate, you should not refinance because that is the determining factor in how much you pay for the car overall.

What About Reducing Your Monthly Payment?
While you may think that reducing your monthly payment is worth refinancing your loan for a longer term, you are paying more than you need to for your vehicle. Remember, your vehicle is a depreciating asset, which means it will be worth less as time goes on. Therefore, the longer that you take to repay the loan, the more you are paying for something that will no longer be worth the investment.

Your Car Only Has So Many Years of Useful Life
It is also important to remember that your car only has so much time before it is no longer useful to you. Generally, a car owner will keep his or her car for five or six years before trading it in. If you owe more on the car than it is worth, you will have to roll over the balance to your next loan. This means that you are going to pay more than what your next car is worth, which creates a cycle of negative equity that can take years to recover from.

Do You Qualify For Refinancing?
One question that you need to consider is whether you will qualify for refinancing. While you may want to get a lower rate or extend your loan term to pay less each month, a lender will still have to check your credit before giving you a loan. Furthermore, you should check to make sure that your current lender will allow you to prepay the loan before the original term is up. While most lenders accept prepayment, you don’t want to risk paying a penalty just to extend the term of your loan or to get a slightly lower interest rate.

How Long Do You Plan on Owning the Car?
If you plan on owning the car for several more years, it may make sense to refinance even if it will cost you more to do so. In some cases, you may be able to make smaller payments now and make larger payments later on to make up for the principal that you are not paying at the moment. This may make it easier to manage your debt now without falling behind in the long run as it relates to building equity in your vehicle.

Refinancing your auto loan may make sense for you if you can get a lower interest rate or want to make smaller payments now and larger payments later on. However, make sure that you avoid the trap of extending your loan in exchange for smaller payments. While you may benefit now, you may lose in the long run when you are more likely to be paying for a car that isn’t worth the monthly payment.

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