Should you refinance or trade in your car? How to choose

Refinancing or trading in a car are two options that can help you get a better deal on a car loan.

Refinancing is great if you want to change your loan terms. You could reduce your monthly payments, especially if your credit score has improved. Trading in a car is best if you’re ready for a new vehicle. It may allow for a larger down payment on a new vehicle — or it may increase the overall loan balance.

Is it better to refinance or trade in a car?

Both refinancing and trading in your car can save you money. The best option for you will depend on your goals.

Refinancing is better if…

You want to stick with your current car and change the loan terms. If your credit score has improved since taking out the loan, you may now qualify for a lower interest rate. A reduced interest rate would mean lower monthly payments and less money paid in interest overall.

Refinancing also has the benefit of keeping your progress toward paying off the loan. Once you pay it off, you can avoid dealing with a car payment entirely.

However, refinancing to a longer loan term will mean you pay more interest over the loan term. Additionally, lenders often have strict qualification requirements, so it may not be an option.

 Trading in is better if…

You want to buy a different car. Trading in — selling to a dealership — can give you more money for your down payment.

Trading in a car is simple. Once you research the value of your vehicle, you can visit different dealerships to see what they will offer.

The end goal is to sell your car and then use the money to pay off your current loan. If you have money left over, consider using it as part of the down payment for your next car. That could help you get better loan terms since you can borrow less on your next vehicle.

However, if the dealership pays less than what you owe on your loan, you must make up the difference to your original lender. Your new lender may offer to lend you extra money to cover the remaining balance. That’s called rolling over your negative equity. It increases your loan balance and means paying more in interest over time, so it isn’t ideal.

How refinancing your car works

Refinancing is essentially the same as getting an auto loan. Here’s how to refinance your car.

1. Gather your documents. You should know how much you still owe on the vehicle and your credit score. Lenders will also want to see your financial information and know more about your vehicle, including its model year and current mileage.
2. Research lenders and rates. Check out current auto refinance rates and the common requirements of lenders. Besides good credit and solid finances, lenders typically require your car to be under 10 model years old and have less than 100,000 miles on it. Most lenders also have a minimum loan amount that you will need to meet to qualify.
3. Apply with multiple lenders. Much like a new auto loan, it’s a good idea to apply for preapproval with banks, credit unions and online lenders. This lets you compare rates, allowing you to pick the best refinance option. Remember to look at the interest rate and fees to determine the true cost of each offer.
4. Confirm how the loan will be paid off. Once you sign the loan documents, make sure the lender either sends you the funds to pay off your loan or pays it for you. Remember to keep making payments until your current loan is paid off.

How trading in your car works

Dealers like to make trading in your car part of buying a new car, but it is a separate process — and should be negotiated on its own. You can shop your trade-in at multiple dealers even if you choose not to buy a car with the one you decide on. Here’s how to trade in your car.

1. Research your car’s value. Resources like Kelley Blue Book and Edmunds list average sale prices for vehicles. Check what your car is worth. This information will help you confirm whether you’re getting a good deal for your trade-in.
2. Check your loan. Every vehicle’s value depreciates over time. But if you owe more than your car is worth, it can make a trade-in difficult. While selling it will still be possible, you may have to cover the remainder of your loan if the sale price is too low.
3. Come prepared to negotiate. Much like buying a car, you can negotiate your trade-in price. If your car is in good condition for its age and has relatively low mileage, you may get a better price from the dealer.
4. Hand over the keys. Once you find a dealer you want to trade in your vehicle with, sign any documents and get the title transferred. From here, you must pay off your car loan or use the money as part of your down payment toward your next ride.

Other ways to lower your monthly payment

You can take a few additional routes to lower your monthly payment, although some of them may cost more in the long run.

Defer your payments

Most lenders will allow you to defer your payments for up to three months if you are experiencing short-term financial hardship. But this doesn’t mean you will skip the payment entirely. Instead, the lender tacks it to the end of your loan term, meaning you must make up the payment later.

Deferral is limited and will not reduce the overall cost of your loan. Instead, you will pay additional interest and possibly additional fees.

To start a deferral, you usually must send a hardship letter to your lender. The letter should outline why you would like to defer payments and when you plan to resume them. The lender may ask for documents showing the hardship you are experiencing, such as bills or your bank balance.

Not everyone is granted a deferral. If your credit score needs work or your income has declined, you may not qualify.

Request a loan modification

Rather than refinancing with a new lender, you can try negotiating with your current lender. It may be willing to extend your loan term — which could lower your monthly payments — or adjust your interest rate.

That said, not all lenders will modify loans. It doesn’t hurt to try, but this approach may be less effective than refinancing.

Pay biweekly

If you struggle to make a large lump-sum monthly payment, try splitting it into two. You will make the same payment, but it could better align with your pay schedule.

As a bonus, biweekly payments result in paying the loan off ahead of schedule, with less interest. This is because you’ll make the equivalent of 13 monthly payments each year, instead of 12.

Next steps

Ultimately, the choice to refinance or trade in your car depends on what you want out of your car.

Refinancing is better if you want to continue driving your car but hope to obtain different loan terms. But if you want to change things up and drive something new, consider trading in your current vehicle to supplement your down payment. It’s a good idea to put between 10 and 20 percent down on a car, and having a trade-in can help ease that burden.

Either way, research your car’s value before searching for lenders or visiting a dealership.

Frequently asked questions

• Should I refinance my car before trading it in?

  It can be a good idea to refinance before trading your car in — as long as you don’t plan on trading your car in immediately after refinancing. Ideally, when refinancing, you’re lowering the monthly payments on your car loan. This, in turn, may allow you to pay more money toward the principal. You can pay it down faster and add equity to the vehicle. After several months of new payments, you could substantially increase your equity, and this can be valuable when you’re ready to trade the car in.

• How long after refinancing my car can I trade it in?

  You can trade in a car at any time after refinancing. The key is ensuring it makes financial sense to trade in your vehicle. You will still be responsible for paying off the loan. Be sure you know what the loan balance is and how that compares to the vehicle’s trade-in value so you don’t come up short.