Borrowing for a car can feel like a questionable financial decision, but there are definitely scenarios where car loans can help you get ahead. For example, new vehicles often come with 0% APR financing offers, and people with great credit often pay low interest rates that are on par with mortgage rates. Not only that, but borrowing for a car may be the only way for you to line up transportation to and from work.

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So, what's the problem? By and large, Americans have gotten into the habit of using car loans to finance more than they can reasonably afford. We know this because not only does the average auto loan amount keeps getting bigger every year, but it also keeps getting longer .

A 2021 report from Experian — the Q3 State of the Automotive Finance Market — just highlighted all the dreadful facts. Here are some of the most troubling statistics:

  • As of Q3 2021, the average new car loan amount was at $37,280, up from $34,682 in Q3 of 2020.
  • During the same quarter, the average new car payment worked out to $606, up from $565 in Q3 of 2020.
  • During the same quarter, the average new car loan term lasted for 69.47 months. That's actually shorter than 2020 when the average loan term lasted 69.64 months. But that’s still almost 6 years!

To sum it all up, we're borrowing more than ever and spreading out the payments as long as we possibly can. Remember that the average new car loan lasted more than 69 months in Q3 of 2021, but that's the average. There are plenty of 84-month car loans out there too, which leave people with a soul-crushing car payment for seven full years.

With all this in mind, you may be wondering if now is a good time to change the way we treat car loans, or to refinance your car loan to get a better deal. There are plenty of scenarios where refinancing makes sense, but there are still times when it's best to stick with the car loan you have.

When To Refinance Your Car Loan

There are four main reasons you should consider refinancing your car loan, and more than one can apply at the same time.

Your Credit Score Has Improved Dramatically Since You Bought The Car

If you had poor credit when you originally bought your car, refinancing right now could help you save on interest or pay your car off faster. That's because, for the most part, the interest rate you can qualify for is tied closely to your credit score.

According to Bankrate , individuals with credit scores in the 300 to 500 range paid an average APR of 12.99% on their auto loans at last count, whereas those with scores from 501 to 600 were charged an average APR of 9.92%. On the flipside, people with fair to excellent credit, or scores from 601 to 850, paid APRs that range from 6.32% all the way down to 2.58%.

If your credit was poor when you bought your car but your score is well over 600 now, refinancing your car loan could be a financially savvy move.

Interest Rates Have Dropped Since You Originally Financed The Vehicle

Maybe your credit score is about the same as it was several years ago. In that case, it's still possible you can benefit from lower auto loan rates that are available today.

For example, the Experian study showed that the average auto loan APR for new cars worked out to 5.38% in 2019, then dropped to 4.23% in 2020 and 4.05% in 2021. If you check rates today and they're lower than they were when you took out your car loan several years ago, refinancing could make sense.

You Want To Pay Off Your Car Faster

If you want to pay your car loan off faster, refinancing into a new loan with a shorter repayment timeline could get you on track. This is especially true if your current car loan is one of the longer ones for up to 84 months.

Of course, you don't have to refinance your car loan to pay off your car faster. Provided your current loan doesn't charge any prepayment penalties, which it shouldn't, you can pay more than the minimum loan payment on your car and accomplish the same thing.

You Need A More Affordable Monthly Payment

Maybe you need a more affordable monthly payment than you have now. In that case, refinancing into a new car loan with a longer repayment timeline, a lower interest rate, or both could help you accomplish this goal.

Just keep in mind that extending your repayment timeline leaves you in debt that much longer. You could also wind up paying a lot more in interest as a result.

Refinancing Your Car Loan: What To Watch Our For

While any of the reasons above could make refinancing your car loan a good deal, there are some serious pitfalls to watch out for. For example, you have to watch out for fees involved in refinancing, including prepayment penalties on your existing car loan and fees related to the new auto loan you're considering.

While most car loans don't have any prepayment fees, you'll still want to read over your loan contract to check. In the meantime, you'll also want to compare new auto loans to look for options that don't charge origination fees or application fees.

Also remember that refinancing your car loan to extend the term can come with its share of pros and cons. You may be able to secure a lower monthly payment, for example, but you can wind up paying off your car loan a lot longer than you wanted.

You should also consider whether refinancing your car loan is worth the time and effort. If you don't owe a lot and you can afford to pay more than the minimum, you can ditch your car loan faster by making larger monthly payments instead.

The Bottom Line

Does refinancing your car loan make any sense? For most people, the answer to this question is a solid "maybe." At the end of the day, it really depends on what you stand to gain by refinancing.

For example, could refinancing help you save time, money, or both? Maybe you could get a lower monthly payment that fits in better with your current income and bills. Consider playing around with an auto loan payment calculator to find out for sure.

By Robert Farrington, Senior Contributor

© 2022 Forbes Media LLC. All Rights Reserved

This Forbes article was legally licensed through AdvisorStream.

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Matthew Etter, CFP®
Partner, President
Signet Financial Management
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Daniel DiVizio, CFP®, CRC®
Financial Planning Director, Wealth Management
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