When you refinance a car, you are paying off your existing loan with a new loan that ideally has better terms. Just as you are able to obtain a vehicle loan whenever you would like, you are also able to refinance a vehicle loan whenever you would like. But there are many factors to consider when trying to determine the best time to refinance a car, which we will discuss here.
While you can refinance your loan at any time, let’s look at when is the best time to refinance a car.
There are many factors to consider when it comes to refinancing. Here are some different things to think about when determining if refinancing now is a good idea.
Look At Your Existing Loan
First and foremost, it is important to look at the terms of your existing auto loan. Sometimes lenders will have prepayment penalties attached to the loan, so it is important to know what the penalties will be if you choose to refinance. If there are prepayment penalties, be sure to do the math to determine if the savings of refinancing will outweigh the penalties.
When determining the best time to refinance a car, it depends heavily on how long you have had your original loan and how many payments are remaining.
It’s the beginning of your auto loan
While you can technically refinance immediately after you get your initial loan, it is generally better to wait a bit before refinancing your car.
60-90 Days: This is the amount of time it typically takes for the title on your car to transfer. You need to wait until all paperwork is finalized to refinance.
Up to six months: It takes some time for your credit score to bounce back after the hard inquiry from your first loan. If you have fantastic credit, this might not be an issue. But typically waiting at least six months will yield more beneficial refinancing options. If you are a first time car loan borrower, it is recommended to wait a year before refinancing your car. This will prove an on-time payment history and make you a more desirable candidate.
It’s towards the end of your auto loan
How does interest on a loan work? Through amortization, the amount of interest you pay gradually decreases over the life of the loan. This means in the beginning of the loan, you are paying off more interest than towards the end of the loan. Let’s look at how car loans are constructed and how car payment amortization works.
Car loans accrue simple interest. This means that if you take out a car loan for $20,000 at 5% interest with a 48 month payment, you will pay back $2,108.12 in interest, with monthly payments of $460.59 for the next four years.
Car loans are amortized and “front-loaded”, meaning that in the beginning your payments aren’t split evenly between your interest and your principal. The amortization schedule below shows how your monthly payments are split up for the first six months of your loan.
Let's look, for example, at a $20,000 loan at 5% interest over 48 months.
Principal Amount: $20,000.00
Monthly Interest Payment: $83.33
Monthly Principal Payment: $377.25
Ending Balance: $19,622.75
Principal Amount: $19,622.75
Monthly Interest Payment: $81.76
Monthly Principal Payment: $378.82
Ending Balance: $19,243.92
Principal Amount: $19,243.92
Monthly Interest Payment: $80.18
Monthly Principal Payment: $380.40
Ending Balance: $18,863.52
Principal Amount: $18,863.52
Monthly Interest Payment: $78.60
Monthly Principal Payment: $381.99
Ending Balance: $18,481.53
Principal Amount: $18,481.53
Monthly Interest Payment: $77.01
Monthly Principal Payment: $383.58
Ending Balance: $18,097.95
Principal Amount: $18,097.95
Monthly Interest Payment: $75.41
Monthly Principal Payment: $385.18
Ending Balance: $17,712.78
As you can see, in the earlier months you are paying more in interest than you are later on. Based on this amortization, you can see the total yearly amount paid in interest.
Year 1 - $894.80
Year 2 - $657.79
Year 3 - $408.68
Year 4 - $146.83
The majority of your interest is paid in the first two to three years that you have your loan. The longer you wait to refinance, the less beneficial it will be to do so.
Current Interest Rates
When deciding if now is a good time to refinance a car loan, look at the current interest rates being offered. Are they better than your original interest rate? Depending on the size of your loan, even a .5 % difference can make a huge difference in the total amount you will be paying.
Your Current Credit Score
Check your credit score using one (or all of the) of the three major bureaus: Equifax, Experian, and TransUnion. Is your credit score better than it was when you initially applied for a car loan? If so, now might be a good time to refinance. Remember that refinancing will result in another hard inquiry on your credit report, which will negatively affect your score for about a year. It may also lower the average age of your accounts, which can negatively affect your credit score. If you need a high credit score for another reason, like applying for a new mortgage or taking out a new lease on an apartment, consider this in your decision to refinance your car.
Your Current Financial Situation
If you need a little more breathing room every month in your budget, now might be a good time to refinance. By reducing your interest rate or lengthening the payment period, you will reduce your monthly payments. On the flip side, if you would like to pay off our loan earlier, refinancing to a lower rate and shortening your payment period will save you money in the long run.
When It Doesn’t Make Sense to Refinance
There are times when refinancing will not be beneficial to you. If any of the following apply to you, it might not be the best time to refinance your car:
- Your credit score has decreased. You will most likely not find a lender who will want to refinance.
- Your vehicle has a lot of miles on it. Most lenders have a minimum loan amount and if the car has depreciated in value significantly, it won’t be worthwhile.
- Your loan is “upside-down”. If you owe more on your vehicle than it’s worth, you likely will not find a lender that will be willing to refinance.
Take a look at your current loan’s terms and payment period, as well as your personal finances when determining the best time to refinance your car.
Depending where you are in your repayment schedule, the benefits of refinancing can vary. At Auto Approve, we are here to help you weigh your refinancing options. If you’re interested in refinancing, use our quote tool and we can help you decide where refinancing now makes sense.