Should you refinance your car loan? Here’s when switching could save you money

New business data points to the fact that When you bought your car, the loan you were offered may have looked reasonable. A couple of years later, things could be different. Interest rates may have changed, your credit profile may have improved, or another lender may be willing to give you a better deal.

That is when refinancing your car loan can be worth considering.

Refinancing essentially means replacing your existing car loan with a new one, usually from another lender. The new loan is used to close the outstanding balance on the old loan, and you then repay the new lender.

The most obvious reason to refinance is a softer interest rate. If you originally borrowed at 11 percentand can now get a similar loan at 9 percent, for instance, switching could reduce the interest you pay over the remaining tenure.

But don't make the decision based on the interest rate alone.

First find out how much of your existing loan is still outstanding and how many EMIs stay. Refinancing generally has greater potential to save money when you still have a sizeable balance and several years of repayments ahead. If your loan is nearly finished, there may simply not be enough interest left to justify switching.

Ask your existing lender for a foreclosure or outstanding-balance statement. Then compare what you would pay if you continued with the current loan against the total amount payable under the new one.

Charges can make a big difference to this calculation.

Your existing lender may levy a foreclosure or prepayment charge depending on the type of loan and applicable rules. The new lender may have processing fees, documentation charges and other costs. Add all of these before calculating how much you would actually save.

The rules on prepayment charges additionally depend on the loan. RBI's current framework restricts regulated lenders from levying prepayment charges on floating-rate loans to individuals for non-business purposes, subject to the applicable conditions. Set-rate car loans, that stated, can have different terms, so check your loan agreement rather than assuming that foreclosure will be free.

Your credit profile can additionally determine whether refinancing is worthwhile.

Perhaps you took your first car loan when you had a limited credit history or several other loans. If your income has since increased, your existing debts have fallen and you have paid every EMI on time, you may now qualify for better terms.

There is another reason people refinance: to bring down the EMI.

Suppose your current EMI is becoming difficult to manage. A lender may offer to refinance the outstanding amount over a longer period, reducing what you have to pay each month.

That can provide useful breathing room, but a softer EMI does not necessarily mean a cheaper loan.

If you stretch the repayment period considerably, you could end up paying more interest overall even at a softer interest rate. Compare the total repayment amount, not just the monthly EMI.

Additionally think around how long you plan to keep the car. Refinancing a loan shortly before you intend to sell the vehicle may add paperwork and costs without delivering much benefit.

Before switching, compare at least five numbers: your current outstanding balance, the interest remaining on the existing loan, the new interest rate, the new tenure and all charges involved in closing and taking the loans.

Refinancing can make sense when there is a meaningful reduction in the borrowing cost and enough time left on the loan for those savings to outweigh the charges.

If the only attraction is a smaller EMI created by stretching the loan for several more years, look more carefully. The best refinance is not necessarily the one that gives you the lowest monthly payment. It is the one that genuinely reduces your overall borrowing cost.