The average car payment for a used car is about $520 a month. That’s the highest amount ever.
Demand for used cars grew during the pandemic, as supply chain issues tightened up the new car market. Plus, people wanted to avoid public transportation, so they bought used cars, too.
That drove prices for new cars up to record levels. Many took out loans to pay for these vehicles.
If you’re one of them you might wonder if you should refinance your car. It’s not always an easy decision, but this is a great time to refinance your car.
Read on to learn why you should and how to refinance your car.
Why Refinance an Auto Loan?
The best thing about refinancing your car is that you can lower your car payments. That puts more cash in your wallet to put towards other high-interest debt, like credit cards.
This makes the most sense if you bought your car and you had a low credit score at the time. You probably got stuck with a loan with a high interest rate.
The interest on the loan is enough to drive your monthly payments up.
If you have a better credit score now than when you originally got the loan, you can get a loan with a better interest rate.
Another situation where car refinancing is a smart move is if you’re having trouble keeping up with your bills. Refinance your loan for a longer term, which lowers your monthly payments.
You’ll end up paying more for the entire loan after adding up the total principal and interest paid, but you will get financial relief.
How Does Car Refinancing Work?
Here’s how refinancing a car loan works. You have an existing loan on your car. You’ve been repaying the loan in monthly installment payments since you first got the loan.
At this point, you reduced the total balance on the loan, and you have some equity in the vehicle.
Refinancing means that you take out another loan with new loan terms and use that money to pay off the first loan.
The new terms of the loan can lower your interest rate and monthly payments. Where you have to be careful with refinancing loans is the length of the loan.
You might be tempted to take out an 84-month loan. That’s seven years! You better make sure the life of the car is longer than the loan.
How to Refinance Your Car
It’s actually pretty easy to refinance an auto loan. The first step, and sometimes the most difficult one, is to determine if refinancing your car loan is right for you.
If it is, then get your financial house in order. Pull your credit report and make sure your credit is in good standing.
Lenders also look at your payment history, income, and income-to-debt ratio. This is the amount of debt you have against your monthly income.
Consider the timing of the loan, too. If you just got the loan a couple of months ago, you’re unlikely to get approved.
You should make on-time payments for 6-12 months before considering a refinance.
Calculate the Loan-to-Value Ratio
The next step is to figure out the loan-to-value ratio of your car. This is the value of the loan divided by the value of the car.
Let’s say that your loan value is $8,000 and the car’s value is $8,000. Your loan-to-value ratio is 100%.
Of course, you want that ratio to be as low as possible. You’ll have a difficult time getting a loan approved if the loan-to-value ratio is higher than 100%.
Check your lender’s website or call customer service for the balance of the loan. To estimate the value of your car, use Kelly Blue Book or Edmunds.
Why are these financial metrics so important? Lenders look at the level of risk they assume with each loan approval.
The loan gets secured by your car’s value. That’s the collateral you put up to get the loan. If you default on the loan, the lender has the right to repossess the vehicle.
Lenders aren’t going to give out loans where the car is worth less than the loan. It’s very risky for them if you can’t repay the loan.
Shop for Lenders
Shopping for refinancing lenders ensures that you get the best rate for your new loan. This is the easy part because you can look for auto refinance quotes online.
Visit various lending sites and enter your information. This is a prequalification, so you’ll get a rough estimate of the loan terms.
You’ll have enough information to compare lenders. Keep in mind that prequalification isn’t the same as preapproval.
Prequalification only looks at basic information. Lenders only do a soft credit check, so your credit score isn’t impacted.
When you get preapproved for a loan, lenders do a hard credit check. Each hard credit check lowers your credit score by a few points.
If you have several hard credit checks at once, it appears that you might be in financial trouble.
When you compare lenders, look at the total cost of the loan. Find out the total amount of interest you’ll pay in addition to the principal. Then look at the monthly payments.
Take into account the lender’s quality of service as well. You want to work with a lender that has great service and approves loans quickly.
Apply for the loan with your lender of choice, get approved, and get your new loan. You’ll repay the old loan and start paying your new loan.
Refinance Your Car and Get a Lower Car Rate
If you want to lower your monthly payments and get a better interest rate, it’s time to refinance your car. Make sure you have a great credit score and you’ll be able to lower your monthly car payments.
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