Should You Refinance Or Trade-In Your Car?

Sometimes financial hardships like a medical emergency or a large unexpected expense can affect your ability to pay your debts and bills. For example, you may no longer be able to comfortably fit your current car payments into your budget due to the changes in your finances.

While one solution may be selling your car to avoid the car payments altogether, there may be other ways for you to reduce your car payments without having to sacrifice your car. Refinancing your car loan or trading your car in for another one are two ways to go about it.

The question is, which route should you take? Let’s compare car refinancing and trade-ins to help you decide which option is best for you.

What Is Car Refinancing?

Like refinancing a mortgage for a home, car refinancing involves taking out a new car loan to replace an existing one. The main reason to refinance your car loan is to take advantage of a lower interest rate or better terms in order to reduce your monthly car payments. 

For instance, let’s say the current interest rate for car loans is much lower than the rate you’re currently paying on your existing loan. By refinancing, you can secure a lower rate, which will reduce your monthly payments and help you save on interest. When refinancing you may also be able to increase the length of your term which can also help lower your car payments.

Factors To Consider Before Refinancing Your Car Loan

The main goal of car refinancing is to help reduce your car payments, especially if you’re financially struggling. But before you refinance your auto loan, consider these factors first.

• More Interest Overall. You may be able to reduce your interest rate by refinancing your car loan, but you could be paying more in total interest over the life of the loan if you extend your loan term. 

• Older Cars May Not Be Worth Refinancing. If your car is older and only has a few short years left in it, refinancing your car loan might not be worth it, as the car value may end up being lower than the car loan itself. This can lead to negative equity, which happens when your car value depreciates faster than you can pay off your loan.  

• Penalty Fees. If your existing car loan contract includes a prepayment penalty condition, you will be charged a penalty fee for breaking your existing car loan to refinance it into a new loan. If you plan on refinancing, make sure that the savings you get from refinancing it more than the penalty fees to break your loan contract. 

What Is A Car Trade-In? 

Another option you have besides refinancing your car loan is to trade in your car for another one, typically one that’s cheaper to finance. While you could always sell your car, trading it in can be easier if you have intentions of getting yourself a new car. 

Trading in your car for a cheaper one that can be financed at a lower rate means your monthly payments will be lower, saving you money every month.  

Before you trade-in your car, you’ll want to find out what your car is worth and the outstanding balance remaining on your current car loan. These two factors will determine what type of vehicle you’re eligible for with a trade-in arrangement. When you opt for a trade-in, the balance remaining on your current car loan and the value of the new car you’re buying will be added to your new car loan. 

Should You Refinance or Trade-In Your Car?

Both refinancing and trading in your car are two effective ways to bring your monthly car payments down. But which option should you choose?

You Should Refinance Your Car If:

Refinancing has a number of benefits. Here are some of the best reasons to refinance your car loan: 

You Want A Lower Rate 

If your current loan is tied to a much higher rate than what’s being offered today, refinancing can help you take advantage of these lower rates to bring down your monthly payments. 

Your Financial And Credit Profile Has Improved

If your finances are in better shape today, you may be able to qualify for a lower interest rate, which can save you money on the interest portion of your monthly car payments. 

Maybe you got a raise at work, increased your credit score, or paid off a lot of your existing debt. Whatever the case may be, a healthier financial profile can put you in a better position to get approved for a lower rate, thereby reducing your monthly payment amount.

Low Or No Early Prepayment Penalty

If your current auto loan contract does not include a clause that requires you to pay a penalty fee for breaking your loan early, then refinancing may be a great option. If it does have a penalty fee, refinancing can still be a good option. Simply make sure that the savings you get from refinancing are higher than the early prepayment penalty fees. 

Find out if you can refinance your car loan under someone else’s name.

You Should Trade-In Your Car If: 

Trading in your car is another great option when looking to lower your car loan payments. Here are some of the best reasons you should trade in your car: 

You’re Okay With A Less Expensive Car

In many cases, trading in your vehicle to reduce your monthly payments means getting a cheaper vehicle. If you’re fine with driving a vehicle that’s not as valuable as your previous vehicle, then trading in your car can be worth it. 

You Have High Equity

If you’ve paid off quite a bit of the principal portion of your current car loan and have a lot of equity, a trade-in might be worth considering. For instance, if your car is worth $7,000 to trade in and you owe $4,000 on your car loan, that means you have $3,000 equity in the car. You can then use that equity towards a new car loan. 

Moreover, you can choose to purchase a car that is worth less than your current car in order to reduce your monthly payments. For example, if you purchase a car worth $5,000, you’ll only owe $2,000 when you trade-in your car due to the equity in your car ($3,000). 

Additional Reading

What to Do if Your Car Loan is More Than Your Car is Worth

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How To Get Out Of Your Car Loan

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Can I Get a Car Title Loan Without a Clear Title?

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Can You Trade-In a Car Before It’s Paid Off? 

The process of trading in your car would be much easier if you have already paid off your car loan in full. But if you still have an outstanding balance on your car loan, the process is a little more complex. 

Most car dealers will let you transfer your outstanding balance to a new car loan, as long as you’re up-to-date on your car payments. In turn, your new car payments could be higher than they would be if you waited until you fully repaid your current car loan. This is where the equity in your car plays a key role. 

If you have positive equity in your car, you can use that equity to be put towards a new car loan. But if you’re upside down on your equity — which means you owe more on your car loan than what your car is worth — you would have to pay that difference out-of-pocket to your original lender before trading in your car. 

Learn more about how to trade in your car if it’s not paid off.

Final Thoughts

Before you choose between refinancing your car loan and trading in your car, assess your current situation and needs. If you want to take advantage of a lower rate to reduce your monthly payments and the fees associated with breaking your loan are manageable, then perhaps a refinance might work. But if you’re okay with a cheaper car and don’t want to deal with any early repayment penalty fees, then trading in your car might be the best option.