Rate dependent on risk profile
Refinancing a car loan means applying for a new loan and paying off the old one. You can refinance a car loan to get a better deal with a new lender and to get out of debt faster.
You should aim to refinance to a new car loan with fewer fees and a lower interest rate than your old one. This saves you money.
You have a $20,000 car loan with a 12% interest rate. It's a 4-year loan and after 1 year you've paid off $5,000. This leaves you with an outstanding debt of $15,000 over 3 years.
Since getting the loan your credit score has improved significantly. You are confident you can now get a much lower interest rate.
You find a new loan with a rate of 7%. After comparing the loan fees and repayments, you apply for a new 3-year loan and borrow $15,000.
At 12% over 4 years, your old car loan repayments were $527 a month. With your new, lower-rate loan the repayments are just $464 a month over 3 years.
Here are 3 similar car loans with different interest rates. You can see how the lower interest rate saves you money over time.
|Loan 1||Loan 2||Loan 3|
|Loan term||4 years||4 years||4 years|
|Total loan cost||$40,077||$36,523||$34,483|
Looking at these examples, loan 3 works out to be $2,040 cheaper than loan 2 and $5,594 cheaper than loan 1.
These are just simple examples and don't include loan fees.
Make sure you refinance to a new loan that's both cheaper than the old one and suitable for you.
Look at the new car loan's application and monthly fees, and any discharge or exit fees that come with your old one.
Let's say you have a 5-year loan term. After 2 years you decide to refinance to a new 5-year loan. This means you're actually extending your 5-year debt into a 7-year debt (2 years of the original loan plus 5 for the new one). This means you'll pay more interest over the longer term.
Choosing the right loan term is about finding a balance between manageable monthly repayments and the overall interest you pay.
If the loan term is too long you'll have small monthly repayments but your lender will get a lot more interest from you. A shorter term means higher monthly costs but you'll get out of debt faster.
Make sure your car is eligible for the new loan before you refinance. If your car is too old or the wrong model, you might not qualify for a particular loan.
Before refinancing, check your credit score. Many lenders determine your car loan's interest rate based partly on your credit score. If your score is good or excellent you have a strong chance of getting a good deal.
If your score has fallen since you took out the original car loan you'll probably need to improve your score before refinancing.
Cars lose value quickly, especially new ones. This can be a problem when refinancing if your car is used to secure the loan.
If you bought a brand new car worth $32,000 and it loses 10% of its value as soon as it's sold and a further 10% a year, after just 2 years the car would be worth $23,328.
If your car's depreciation outpaces the outstanding loan amount you might have a harder time refinancing. This is less of a problem if you've paid off a good chunk of the loan or if you paid some of the car's total cost upfront.
Every loan application impacts your credit score. Avoid applying for multiple car loans at once. You can only refinance to one loan, so find the best one for you, make sure you're eligible and then apply.
If your credit report has multiple loan enquiries then a lender will consider you a higher-risk borrower. You may end up on a higher rate or have your application rejected.
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