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Think Twice Before Refinancing Your Auto Loan

You love your car. You are however, less then enamored with your car loan. And since your lottery numbers have yet to prove lucky, and a large inheritance is not in your future, your automobile debt is not about to vanish any time soon. As far as you’re concerned, your only hope is to refinance.

While refinancing may be a viable option in your situation, you will need to think twice and examine all the facts before signing another loan document.

The Upside of Refinancing

There are times when refinancing your car loan is the perfectly logical solution. If your current situation fits into one of these categories, you may want to consider renegotiating new terms.

1. Lower Interest Rates. Were interest rates significantly higher when you took out your car loan than they are now? Did you have to settle for a hefty interest rate because of bad credit? If interest rates have dropped or your credit score has improved, refinancing your vehicle may save you a bundle of cash. In fact the former President of Credit.com, John Ulzheimer, states in the Chicago Tribune‘s “Auto Refinance Risks and Benefits” that “if your credit score improves, even by just 50 points, you should refinance the loan.”

2. Shorter Term. If your loan has a term lengthier than the life expectancy of your car, you may want to consider refinancing. A shorter term can not only enable you to own your car “free and clear” much sooner, but it can also save you money on interest. In “Should You Refinance Your Car Loan?,” Executive Editorial Director and Market Analyst for Kelley Blue Book, Jack Nerad, advises anyone “in a lengthy auto loan–with an original five- to eight-year term–to research auto refinancing.”

3. Improve Your Credit Score. If you are striving to clean up your credit rating, it may be in your best interests to refinance. When you take out a new loan, the old one is paid off. This will be reflected on your credit report, improving your credit score.

Think Twice Before Refinancing Your Auto Loan

The Downside of Refinancing

There are times, however, when refinancing is a bad idea–no matter how much you loathe your loan payment.

1. Longer Term. If you are considering lowering your payments by extending the length of your loan, you will need to do the math carefully. In many situations, your monthly payment may decrease, but when you add up the additional months’ worth of payments and the interest expense involved, you wind up paying exorbitantly more for your car. What are the risks with Refinancing Your Auto Loan?” reminds us that, in some cases, lenders will not even consider refinancing older cars. If your car will soon be passing it’s prime, you are highly unlikely to be approved for any term–let alone a longer one.

2. Prepayment Penalties. Some loans are plagued by penalties for paying a loan out early. It is also possible that your new refinanced loan will involve other charges like registration and lien-holder fees. It is important to factor these additional costs into your decision.

3. Upside Down Financing. Upside Down Financing, also known as Negative Equity, occurs when you owe more money on your car than the car is actually worth. This is both a borrower’s and a lender’s nightmare, but it occurs more often than you may think. Lenders hate these scenarios because even after repossessing the vehicle, they will still be owed money. And, for the borrower, it increases the likelihood that your car may die while you still owe money on it. Refinancing a car for a longer term often leads to this situation and, therefore, is a big no-no.

There are times when refinancing a vehicle makes perfect sense, but this is not always the case. Make sure you get all your facts straight, calculate your numbers carefully, and proceed with caution before putting your name on that dotted line. And don’t stop playing the lottery.

What advice can you offer someone considering refinancing their car?