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I was telling a friend lately that my car payment was too high, and he mentioned that I should try to refinance it. I had never refinanced a vehicle before, so I decided to do some research to see if this option was right for me.
So, what is refinancing a car? Refinancing a vehicle is when a new loan is used to pay off the original one. The car would be used as collateral for the new loan. The refinanced loan will create a new agreement between the lender and the borrower. This agreement will be similar to the one when the vehicle was first purchased. A new interest rate, monthly payment, and duration will be established. A refinanced loan will typically lower your monthly payment because of a lower interest rate or extended loan period.
If you meet the qualifications for a lower interest rate, you may end up paying less total interest for the life of the loan. This may not apply if the loan duration is extended. If the loan term is extended, the monthly payment will probably be lower. In this situation, the borrower may end up paying more for the vehicle over the life of the loan. A shorter term will likely increase your monthly payment, but the loan will be paid off faster with possibly less interest overall. Some lenders will charge fees to refinance a car loan. These fees may be charged upfront or be included in the loan where they will be subject to interest.
Refinancing a vehicle is an important decision that shouldn't be taken lightly. You have to make sure it's the best option and deal for you. It is essential to weigh the advantages and disadvantages of refinancing your vehicle before starting the process.
Car Refinancing Pros and Cons
One of the primary benefits of car refinancing is to lower your interest rate. In many cases, you are probably paying a high-interest rate because of bad or no credit at the time of the original loan. It is important to make sure that your credit situation is good to obtain the lowest possible interest rate. A lower interest rate can save you hundreds or thousands over the life of the loan and possibly allow you to pay it off faster.
If you owe less than what your vehicle is worth, refinancing your car may put money back into your pockets. This is similar to equity in a home. For example, your car is currently valued at $10,000, and you still owe $4,000 on the loan. You may need money for home repairs, a vacation or to pay off other bills. You could refinance your car for $7,000. By doing this, you could pay off your original loan of $4,000, and pocket the remaining $3,000. Also, you would still owe less on the vehicle than its value by $3,000.
Another popular benefit of refinancing your car is the ability to lower your monthly payment. Many people seek to reduce their car payment because of a life-changing event, increased debt or merely because they feel it is too high. Refinancing gives you the option to extend your loan repayment terms. Typically, a longer duration translates into a lower payment. For example, if you currently have three years left on your loan, you may be able to extend it to four or more years. Depending on your interest rate, adding an extra year or more to the loan can dramatically lower your payment, if you can negotiate a lower interest rate. The tradeoff is that it will take you longer to pay the loan off, but you will have extra money in your budget every month.
If you decide to refinance your vehicle and extend the loan, it will cost you more in the long run, despite a lower interest rate. This is often an overlooked drawback of refinancing because consumers tend to focus on just the payment and interest rate. It is important to use a loan calculator before agreeing to any terms. For example, there is a substantial difference between paying 5% interest on a two-year loan compared to a five-year loan.
It is not uncommon to receive a higher interest rate when you refinance your car. This is especially true if your vehicle is older or your credit score is low. Sometimes this can be ignored if the consumer is in a desperate situation. It is important to be patient and shop around for the best rates for your particular situation.
How to Refinance Your Vehicle
- Collecting your documents– The first step in the refinancing process is to gather all of your pertinent documents. These typically include proof of income, proof of residence, proof of insurance, credit report, vehicle information, and current loan documents. Proof of income will usually be a W-2. If you are a freelancer or own your own business, your income taxes will most likely be required. Proof of residence will be a lease, mortgage bill or any bill with your name on it. A credit report is not needed, but it can be helpful in the process, and you can ensure that it is similar to the lender's report. Proof of insurance will be required before you can be considered for a loan. This should not be an issue since your current lender will likely require full coverage insurance. The lender will need the vehicle identification number(VIN) and other necessary information about the vehicle before it can be used as collateral. The current loan details will be used to see how much you owe on the car.
- Determine if refinancing is a good idea– The goal of refinancing is to get a better overall deal over your current loan. This may be difficult if your credit or debt to income ratio is bad. This is why it's important to pull your credit score before visiting a lender. If it is bad, you can probably save yourself some time because most likely you will be denied or receive a bad deal. For a good deal, you will need a score at or above 700. The best deals will be reserved for scores at or near 800.
- Compare rates– It is best to compare rates between at least 3-5 reputable lenders before choosing one. This is typically easier to do online. Keep in mind if you apply, some lenders may do what's called a hard pull on your credit report. This can slightly lower your credit score. Numerous pulls during a short period while refinancing will usually be counted as one pull. The essential items you want to look for are annual percentage rate (APR), loan terms, and any penalties or fees. Some companies will charge you a fee for the loan or penalize you for early prepayment or late payments. The APR should always be lower than your current loan, and the terms should meet your current needs.
- Decide on a lender– After making your comparisons, you will apply and begin the process with the lender of your choice. You want to make sure that all your pertinent information and documents are available. You want to make sure that the loan terms, APR and other information from your comparison match the actual loan you will be receiving. This is important because many lenders will advertise specific terms and APR but the fine print can say something different.
- Payoff old loan– Once approved, the lender will immediately pay off your old loan. Some lenders will pay off the loan for you, while others will give you the money to pay it off. Your old lender will transfer the title for the vehicle to the new lender who will hold on to it until the new loan is repaid. If your original loan payment is due around this time, it is best to call your old lender and explain that you are refinancing.
- New Monthly payment– Your new lender will now let you know when your first payment is due and other relevant information. It is important to turn off any automatic payments on your old loan at this time. If possible, you can make extra payments to pay off the loan earlier. This would not be the case if you refinanced to free up extra money.
I currently have a lease on my vehicle, can I refinance it? Yes, most lenders offer lease buyout programs.
Are there any vehicles that can't be refinanced? Typically commercial vehicles, salvage cars or conversion vans can't be refinanced. Also, titles can't be registered to a business.