Used car prices rose by more than 40% between January 2021 and 2022 – and that could be good news for those willing to refinance their car loan.
With chip shortages and other market factors holding back vehicle production, car buyers have been forced to look to the used car market, and their demand is driving up prices.
If you’re a car owner, this is good news, as your car may be worth *much* more than you think. And if you’re among the many consumers looking for a break from the ever-increasing cost of living, refinancing your car loan could be part of the solution.
What is auto refinancing?
Car loan refinancing involves replacing your current loan with a new one. With auto refinancing, you can borrow an amount equal to your original loan balance, or borrow up to the full market value of your vehicle and use the money to pay off your original loan.
Many banks, credit unions and online lenders offer automatic refinancing. Like other loans, you will have to qualify based on the lender’s requirements.
The better the condition of your vehicle and the higher your credit scores, the more likely you are to get good, affordable offers from multiple lenders.
When does refinancing a car loan make sense?
Market forces can affect your chances of getting a new loan with better terms. Here’s why now is one of the best times to consider auto refinancing:
The prices of vehicles have increased a lot
In June 2022, used car prices hit an all-time high, and in July, the Bureau of Labor Statistics reported (opens in new tab) that used cars had experienced more price inflation than almost any other item on the market.
What does this have to do with refinancing? The value of your car affects your ability to refinance to a more affordable loan. The higher your loan-to-value (LTV) ratio—which compares the value of your car to your loan balance—the better your chances of saving money on a new loan.
Under normal economic conditions, new cars typically lose about 20% of their value within the first year of ownership and another 15% to 25% over each of the next four years. This means that a three-year-old vehicle can be worth less than half the original purchase price.
By comparison, CoPilot’s Return to Normal Index (opens in new tab) found that used cars skyrocketed to 42% above their normal values in June 2022. But prices are likely to fall until the end of 2023, when car shortages are forecast to recover, so now it could be the best time to consider refinancing.
Interest rates have been reduced
Despite the Federal Reserve raising interest rates, some auto refinance lenders still advertise rates below 3%. This means that vehicle owners may still be able to save money by refinancing at low rates.
According to a report (opens in new tab) from RateGenius, an online auto loan marketplace, consumers who refinanced in April 2022 lowered their rates by an average of 7.24% and lowered their monthly payments by an average of $83.82.
While the Fed’s 2022 rate hike has some manufacturers raising rates by around 1% on new vehicles, there could be a few more hikes before the end of the year. And these rate hikes will cut into your potential savings from an auto refinance.
How refinancing a car loan can save you money
Each lender offers different rates and terms, but these are some of the main benefits you can get from auto refinancing:
Lower monthly payments
Getting a new loan can mean a lower monthly car payment.
If your new loan is smaller than the original loan, or if you extend your repayment term, your new monthly payment amount may be lower than what you currently pay.
However, it’s worth noting that extending the repayment time frame will increase the total interest charges you accrue, so this option is only recommended for borrowers who have cash flow issues.
Reduced interest rate
You may be able to get a better rate on a new loan.
Lower interest rates are usually available to borrowers whose credit has improved since taking out their original loans, or if the market has caused rates to drop.
Access to capital
If you have equity in your car — meaning it’s worth more than the current loan balance — refinancing can put money in your hands.
With a cash-out refinance, you can borrow more than the amount you need to pay off your old loan and use the extra money to pay off expensive debt, like credit cards.
For example, if your car is valued at $20,000 and you currently owe $15,000, you can get a cash-out refinance loan for the full value of the vehicle. Once you’ve paid off your original loan, you’ll be left with an extra $5,000 that you can use to pay off high-interest debt.
Note that it is not recommended to cash out your equity for any purpose other than paying off high-interest debt, as doing so would increase your total debt load.
Taking a break from payments
Refinancing your auto loan can give you a temporary break from car payments.
When you are approved for a refinance loan, the new lender may give you a grace period or a time limit before your first payment is due. Some offer grace periods of up to 60 to 90 days.
It’s worth noting that interest is likely to increase during the grace period, so you should calculate the overall cost before deciding to delay payments.
Should I refinance my car loan?
You will benefit more from auto refinancing if any of the following circumstances apply:
- The value of your car has increased: This is likely to happen if you own an electric or hybrid vehicle or if you own a nearly new vehicle (less than three years old), but older vehicle values have also increased by over 40%. You can check the market value of your car at Kelley Blue Book (opens in new tab) and Edmunds (opens in new tab).
- Your credit has improved. If your credit scores have gone up since you got your original loan (which usually lasts at least six months), you likely qualify for better rates and terms.
- You first borrowed from a seller. Agents usually offer higher fees and charges than other lenders. If you can refinance a dealer-backed loan through a bank or credit union, you’ll likely save money on future car payments.
You may want to hold off on refinancing if you only have a few payments left on your current loan or if your lender has a prepayment penalty.
If refinancing isn’t right for you, other cost-saving measures are still available. If your car is worth more than you owe, you can save money by canceling your GAP coverage.
The US Department of Energy estimates that vehicle owners can also reduce their fuel economy by up to 10% through better driving and maintenance. (opens in new tab)which includes keeping tires properly inflated, changing clogged air filters and regular maintenance.