Pros & cons of refinancing your car loan

Car loan refinancing is nothing but a clever debt management strategy under which you can take a new loan to repay the ongoing loan. To some, it may sound like a great idea, while to others, it could be clearer. And that’s because it is not always the right way to go in your finance journey. It will only prove beneficial if one can replace the ongoing loan with another one with a lower interest rate and better terms. That makes sense, right?

Understanding the workings of refinancing

Before we explore the pros and cons of refinancing a car loan, let us first get a clear understanding of how loan refinancing works. So, as mentioned, refinancing is replacing an old loan with a new loan. While the borrower still owes the remaining principal amount, the terms have now changed, including the loan tenure, interest rate, among other factors.

Now, why do people opt for loan refinancing? Some car owners go for refinancing to pay off their auto loan quickly, while others go for a more manageable monthly payment cycle, thanks to longer loan tenure. While the first option will lead to saving in the long run (quick loan repayment coz of lower interest payment), the latter one leaves you with more cash in hand at the end of every month, which can be put to work (invest) or be saved. Thus proving the worth of refinancing a car loan.

Also Read: When and why to refinance your car loan

The next important question is when to refinance a car loan. Refinancing a car loan makes sense only under the right circumstances including -

• When a loan with more favourable terms is available
• When higher income is at the disposal
• When the credit standing of the borrower has substantially improved
• Lower interest rate
• When the loan is relatively new (else refinancing cost will put you at a net loss for a small loan amount)
• When there's an emergency (need to do cash-out refinance or reduce monthly payments)

Even if you tick all the boxes, certain pre-requisite conditions must be met before you apply for car loan refinancing. The list includes -

• Financial stability, in general
• Market condition at the time of refinancing
• Through assessment of existing loan terms

However, there are times/conditions when refinancing is not a viable option. These include higher interest rates and when a borrower is close to paying off the debt. While the former will increase the overall loan payment, the latter will prolong the loan term.

Refinancing a car loan: Pros & cons

Are you still unsure if refinancing is the best option for you in your financing journey? Here are some pros and cons that will help you make a well-informed decision.

Also Read: A step-by-step guide to refinancing your car in the Philippines

Pros of refinancing a car loan

#1 Lower interest rate

Refinancing a car loan leads to lower interest rates, which decrease your monthly payments and your debt-to-income ratio. The latter will help you get a loan in the future, and that too with a better interest rate.

However, to qualify for lower interest rates, a borrower either needs to beef up his/her finances, have a good credit score, or wait for the banks to drop the interest rate.

Further, we suggest you compare different lenders' refinance interest rates to ensure you get the best deal.

#2 Lower monthly payments

Two factors must be considered for a borrower to qualify for lower monthly payments: longer loan payment terms and a competitive interest rate.

We suggest you check how different interest rates affect your monthly payment and total amount. If a longer loan term and reduced monthly payment work for you, then we’d say opt for it. Now that your monthly payments have been reduced, we’d suggest investing the difference amount and earning back the money that has been potentially lost because of the extended loan term.

However, a loan provider will only approve such terms if the borrower has a good credit score.

So, work towards improving your credit score, as it has a lot of impact on your financial health.

Also Read: Uncovering the impact of credit scores on car loans in the Philippines

#3 Early loan payoff

If you are someone who wants to be debt-free sooner rather than later, then refinancing is the way to go. You can find a loan provider who agrees to a shorter loan term, but remember, it would mean higher monthly payments.

#4 Improved cash flow

Opting for refinancing allows you to reduce your monthly payments, which in turn will improve your cash flow. This means you’ll have more money to deploy every day that can go towards investments, expenses, etc.

#5 Debt consolidation

Refinancing allows you to consolidate your debt, which will reduce your stress levels considerably. So, all you need to do is find such loan providers who provide such services. If you can secure such a provider, there will be no need to open up several tabs to meet your financial obligations, as all your debts, including car debt/s will get tied up.

#6 Obtain additional funds

With cash-out auto refinancing, a borrower can pay off his/her existing auto loan and take out some of his/her car’s equity as cash. Though the overall debt will be high, you'll get a much better interest rate and shorter loan term.

Also Read: How to budget for your car loan repayment effectively

Cons of Refinancing a Car Loan

Though refinancing auto loans or loans in general offer several advantages, being a financial resource comes with its own set of setbacks. So, before you go out to get a loan to refinance, keep the below-mentioned points in mind.

#1 End up paying more interest

Some borrowers opt for an extended loan term to reduce their monthly payments. While this move offers more cash flow, it also increases their overall interest payment.

#2 Upside-down car loan

When a car owner gets upside-down on his auto loan, it simply means that he/she owes more than the car is worth. It is also referred to as a negative equity car loan or being underwater on the loan. Now, a refinance can put the borrower upside down on the loan. While some of you can accept this short-term sacrifice, remember an upside-down auto loan can also complicate the car’s resale journey.

#3 Beware of longer loan terms

While longer loan terms lead to fewer monthly payments and, therefore, more cash in the bank every month, sometimes a borrower gets too comfortable with the extended loan term and ends up paying far more than the original loan amount.

Bottom line

Car refinancing has several applications. While some opt for it to lower their monthly expenses, others use it to tap into equity (via cash-out refinance). While this financing tool can help a borrower with several financial objectives, one should always consider the disadvantages before proceeding on this route.

Also Read: Personal loan or car loan: Finding the right financing option for your car