If you buy a car and borrow money to pay for it, then you are financing the purchase of the car. Later down the road, you may realize that you have a poor interest rate or that your payment is too high. One way to reduce your interest and payments is to try to refinance the loan. This is the act of borrowing money to pay off the first loan. You'll then owe a debt to the refinance company.
Refinance a Car Meaning and Process
When you buy a property and finance its purchase, the lender usually takes a security interest in the property. That is, the property is the collateral for the loan. If you stop making your payments, the lender can take the property to satisfy the debt. Refinancing is the process by which you can get a new lender to loan you enough money to pay off the old loan. The old lender releases the lien on the title, and the new lender takes a security interest on the vehicle.
Benefits of Refinancing a Car
Refinancing can help you obtain more favorable loan terms than you already have. For example, if you bought your car when you had bad credit and have a 19 percent interest rate but your credit has improved since the purchase, you may be able to get a new loan at a much lower interest rate. A lower interest rate means a lower payment. Another reason to refinance is to get a shorter term. Perhaps you've had a pay rise and have more disposable income so you can afford to pay in repayments each month. Refinancing to a shorter term will likely increase your monthly payments but you'll own the vehicle free and clear in a much shorter time frame.
Watch Out for Negative Equity
The difference between the value of property and the amount you still owe is called equity. You might have difficulty refinancing your car if it's worth less than what you owe on it, which is called negative equity. For example, if your car's book value is $3,000 and you owe $1,700, your car has $1,300 in equity. But if you owe $5,000 on that car, you have negative equity of $2,000. A lender is more likely to take a security interest in property that's worth what it lends you, because if it has to repossess the car and sell it, it's more likely to get most of its money. Some lenders, however, will refinance car loans even if the car has negative equity, but only up to a certain percentage.
Best Place to Refinance a Car
Many banks have vehicle refinancing loans. Shop around for the best rates you can find and make sure to speak with the bank directly about the terms of a refinance loan. Find out what your new interest, your new payments and your new term will be and decide if the refinance will actually help you. While a much lower payment may seem attractive in the short term, if the new loan would go five years longer than your current loan, it may be smarter in the long run to keep the loan you have.
- Road Loans: What is Refinancing a Car?
- Auto Trader: 5 Reasons Refinancing an Auto Loan May be Right for You
- Debt.org. "Mortgage Re-Fi." Accessed Aug. 30, 2020.
- Board of Governors of the Federal Reserve System. "Interest-Only Mortgage Payments and Payment-Option ARMs — Are They for You?" Page 12. Accessed Aug. 30, 2020.
- Board of Governors of the Federal Reserve System. "A Consumer's Guide to Mortgage Refinancings." Accessed Aug. 30, 2020.
Rebecca K. McDowell is an attorney focused on debts and finance. She has a B.A. in English and a J.D. She has written finance and tax articles for Zacks and eHow.