If your car payments are taking a serious bite out of your budget you may be able to get some relief by refinancing your loan. Refinancing can lower your payment and reduce the amount of interest you’ll pay, giving you the financial breathing room you need. Getting a better deal on your car loan is a fairly straightforward process but there are some potential pitfalls you’ll need to steer clear of. Here are a few tips that can help you decide whether it’s the right time to refinance.
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Check Your Credit
Just like any other loan or line of credit, the interest rate you’ll pay is tied to your credit score. Generally, the better your score, the lower the rate will be. If your score has changed dramatically since you took out your original car loan it can have a significant impact on whether or not you’ll be able to refinance. Knowing what your credit looks like you before you start talking to lenders can give you an idea of where you stand.
There are several different scoring systems that lenders can use to evaluate your credit worthiness but FICO scores are typically the most common. Your FICO score is based on your payment history, the types of credit you have, the amount of debt you have versus your available credit and the number of inquiries you have for new credit. FICO scores can range from 300 to 850 and the closer you are to the upper limit, the better off you’ll be when applying for an auto refinance loan.
Consider the Loan Term
The whole purpose of refinancing is to try and save money but you could actually end up paying more if you’re not careful. You may be shaving points off your interest rate and paying less each month but it won’t make much of a difference if you have to extend your loan term. A longer term means you’ll be paying more interest over the life of the loan, which may not add up to any real savings at all.
If you only have a couple of years left in your current loan, you probably won’t benefit that much from refinancing since you’ve already paid most of the interest. The only instance where it could potentially work to your advantage is if you’re planning to continue making the same payments in order to pay the loan off early. If you still have three to five years left on your loan, refinancing may not shorten the repayment period but it could still save you some money on interest.
Even if you’ve got great credit, you may find it difficult to qualify for a refinance loan due to specific lender requirements. For example, some banks may put a cap on how much you can borrow to refinance a car or they may limit what kinds of vehicles are eligible. There may also be restrictions on age which means you may have trouble getting financing if your car’s value has depreciated significantly.
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When you’re looking for the best rate on an auto refinance loan you want to compare as many lenders as possible. Your local bank is a good starting point but it’s also a good idea to look at credit unions in your area since they tend to offer lower interest rates. There are also plenty of online lenders to choose from and applying for a loan is relatively easy.
Read the Fine Print
Before you sign a new loan agreement, you need to go over your current loan to make sure you won’t get hit with any penalties for refinancing. For example, you may be charged a prepayment penalty for paying off the loan ahead of schedule. If you get hit with any unexpected fees it may detract from the savings you’ll get by refinancing.
There may also be additional fees associated with the new loan, such as an application fee, points origination fees or processing fees associated with changing the title to the new lender. All these fees can add up so it pays to know exactly what you’re paying before you close the deal.
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There are plenty of good reasons to refinance but you need to run the numbers to make sure it’s the best move. Focusing on the short-term savings without looking at the bigger picture could end up costing you more in the long run.
Photo Credit: Rael Hodgson