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Refinancing a car loan involves replacing your current loan with a new one, usually with a different lender. It can make sense to consider refinancing if you qualify for a lower interest rate, you need a lower monthly payment or you want to tap some of the positive equity you've accumulated.
Current refinance rates range from roughly 4% to 25%, depending on the lender, how old your vehicle is and your creditworthiness. As a result, it's important to carefully consider your reasons for wanting to refinance before moving forward.
When Should You Refinance Your Car Loan?
Refinancing your car loan can potentially save you money and provide some budget relief. However, it's important to know your situation before pulling the trigger. Here are some situations where it makes sense to refinance.
Your Credit Score Has Improved
If you've taken steps to build your credit since you first bought your car, you may be eligible for a lower interest rate than what you're currently paying. This can be the case even if market rates haven't budged.
Before you consider refinancing, get free access to your Experian credit report and FICO® Score☉ to see where your credit stands. In addition to evaluating your credit health, look for opportunities to make additional improvements to maximize your chances of saving money.
Interest Rates Have Declined
Market interest rates have been steadily rising since 2022, according to Experian's State of the Automotive Finance Market Report for the second quarter of 2024. However, auto loan rates are expected to start going down again following the Federal Reserve's decision to slash its federal funds rate in September 2024.
Experts anticipate there will be more rate cuts throughout the rest of this year and next year, and auto refinance rates should follow suit. As they do, it's a good idea to regularly check lender offers, so you can compare them to your current loan terms.
Learn more >> What Is a Good Auto Loan Interest Rate?
You Need a Lower Monthly Payment
Scoring a lower interest rate can help you secure a lower monthly payment, but it's not the only way. When you refinance your car loan, you may also have the option to extend your repayment term.
Of course, this will result in more interest charges over the long run. However, if you're on a tight budget and you're worried about not being able to make your monthly payments, it can be a worthy tradeoff.
Learn more >> What to Do if You Can't Afford Your Car Payment
You Want to Tap Some of Your Vehicle's Equity
If you made a sizable down payment or you've paid down a significant amount of your loan, you may have a lot of positive equity in your vehicle. In this event, you might be able to tap some of the equity in the form of a cash-out auto refinance.
If interest rates are favorable, tapping your car's equity could be an affordable way to consolidate high-interest debt, pay down medical bills, bolster your emergency savings or make some home repairs or renovations. However, be sure to look at the new monthly payment and overall interest costs to determine whether it's the right move.
When Not to Refinance Your Car Loan
Although there are some clear advantages to refinancing your car loan, it's not always the best choice. Here are some situations where it may not make sense.
You're Underwater on Your Loan
If you owe more than your car is worth, you may have a hard time finding a lender willing to approve a refinance loan. Even if they do, you may need to pay the difference to your original lender before you can complete the process.
You can get an idea of your car's value by using an online valuator tool, such as Kelley Blue Book, J.D. Power or Edmunds.
Your Loan Has a Prepayment Penalty
You typically don't have to pay closing costs on an auto refinance loan. However, some auto lenders charge a prepayment penalty if you pay off your loan too early. In most cases, it'll be roughly 2% of your outstanding loan balance.
Lenders aren't allowed to include the penalty on loans with repayment terms of 61 months or longer. If your loan's original term was less than that, though, review your loan agreement to see if there's a penalty and what the terms look like.
Your Credit Score Hasn't Improved
If your credit score hasn't increased—or worse, it's gone down—since you took out your existing loan, you may have a hard time securing a lower interest rate, even if market rates have declined.
Fortunately, some auto lenders allow you to get prequalified with just a soft credit check, which won't negatively affect your FICO® Score. This can be a great way to evaluate your options before moving forward.
Your Vehicle Is Old
Refinance loans tend to be more expensive if your car is more than a few years old, but if it's 10 years or older or has more than 100,000 miles, you may have a hard time finding a lender willing to work with you at all. In this event, it may make more sense to focus on paying off your existing loan.
Alternatives to Refinancing
If you've determined that an auto refinance loan isn't your best option, here are some other potential options to consider.
Trading In or Selling Your Car
If you're struggling to keep up with your monthly payments, trading in or selling your car and getting a less expensive model may be more financially sound.
Start by getting an estimate of how much your car is worth, and then evaluate whether it's better to sell it or trade it in.
Consider Leasing
If you have a new car but want a lower monthly payment, you could consider leasing instead of owning. According to Experian data, the average monthly lease payment is $586, while the average payment for a new car loan is $734.
Before you make that decision, however, carefully consider all the pros and cons of buying versus leasing.
Request a Loan Modification
If your credit score is in poor shape, buying or leasing another vehicle may not be an option. In this case, consider reaching out to your lender to see if you can get your loan modified.
A loan modification may extend your repayment term, reduce your interest rate, reduce your monthly payment or provide short-term forbearance as you manage your financial obligations.
Build and Maintain Good Credit to Maximize Your Savings
Even if you don't have time to improve your credit score right now, it's a good idea to prioritize good credit habits to make it easier to qualify for favorable financing terms the next time you need a loan.
With Experian's free credit monitoring service, you'll get access to your FICO® Score and Experian credit report, along with real-time alerts when changes are made to your report. Regularly monitoring your credit can help you better understand how to make improvements and protect yourself from potential issues before they get out of hand.