Refinancing is a way to replace an existing car loan with a new car loan. Your new lender provides you with a new loan that pays off your old loan. Refinancing on car loans is generally done to help lower monthly payments. The original lender will release its lien on your car after it has been paid off by the new lender, who now has the lien on your car. The original lender no longer has the right to repossess your car, but the new lender will have the right to take it back if you default in your loan payments.
Purpose
The general purpose for refinancing a car loan is to reduce your monthly payments by either extending your repayment period or taking advantage of reduced interest rates. For example, if your credit has improved significantly since you first took out your car loan then it may be wise to refinance to obtain a lower interest rate. If market interest rates are lower then it may be advantageous to refinance. Additionally, if you have a significant amount of equity in your car, then you may be able to pull some of that equity out as cash when you refinance.
Extension
A refinance loan can also help you lower your monthly payments by extending the time by which you have to repay the loan. For example, if you have only two years left on your existing auto loan then you may be able to refinance into a new five-year loan with much lower monthly payments over those five years. Ultimately, this will increase the total amount that you pay in interest on your auto loan, but it can give you more breathing room in your monthly budget.
Effect
The effect of a refinance is that your original loan disappears and the new loan takes its place. The new lender will require an application, and upon approval and closing, will pay off the full amount owed to your first lender. Your new loan may have terms that are different than your original loan, including the repayment schedule, interest rate, and in some instances, the payoff or principal balance.
Disadvantages
Refinancing may not always be a benefit. First, refinancing sometimes requires a new down payment or the payment of application and lender fees. For example, the new lender may charge you a fee for processing your application or a loan origination fee. Second, if your credit has gone down since you obtained your first loan then you may not get the best interest rate on your refinance loan, which could result in you paying more interest over the life of your loan.
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