What is Car Refinance?
It’s relatively easy to refinance a car in South Africa but the question is why would you do it? Typically, people refinance a car to secure a lower interest rate which decreases their monthly car payments and saves money over time.
The aim of refinancing a car loan is to lower your interest rate, reduce your monthly payments, possibly get some cashback or shorten the loan period. However, there are a few risks involved. You may pay more in the long term, you may not save as much each month as you hope to and you may pay high penalty fees for refinancing.
Do your homework carefully before making the decision to refinance your vehicle. It has to be the right time with the right interest rate and loan period for it to work for you. Refinancing is the logical option for some people but not everyone.
Why you should refinance your vehicle
Did you finance your vehicle through a bank or car dealership at a high interest rate? Have your circumstances changed, for example your monthly income has increased and your credit score has improved? Then you may qualify for a lower interest rate and can enjoy significant savings on your monthly loan payments if you refinance your vehicle.
Refinancing your vehicle means you can save a great deal of money over the remainder of the repayment period because a lower interest rate means you pay less each month. If you’re not offered a better interest rate on a new loan, there are also benefits to extending the amount of time you have to pay off the car loan.
Why use your credit card and get deeper into debt when you could take advantage of the benefits of refinancing your car? It’s a cheaper option and works to your advantage by improving your credit rating.
Here are two options to consider:
- If the amount you owe on your car is lower than the retail value of the car, you can refinance it to get cash out but continue to pay a similar monthly payment.
- If you have settled your car finance loan in full, you can refinance it for its current market value and get the full amount out in cash and then pay an instalment based on a lower interest rate (which is always lower than interest on credit cards or personal loans).
Improving your credit rating stands you in good stead for future credit applications. The interest rate offered by financial institutions is based on an individual’s current credit profile. The better your credit rating, the better interest rate you will be offered.
Exactly how much cash you get out of a refinancing deal depends on the market value of the vehicle, the outstanding balance owed on the vehicle and your current credit rating.
Let’s look at this example:
Your car is fully paid up and has a trade value of R100 000. You would receive the full R100 000 in cash. However, if the trade value of the vehicle is R100 000 and you still owe R40 000 to the bank, you will only get out the balance which would be R60 000.
What does car refinancing involve?
When you refinance your vehicle, you take out a new loan to pay off the balance of your existing car loan. However, the whole purpose is to pay a lower monthly payment and save money by securing a better interest rate.
The majority of people who take out a car loan to buy a care are offered a fixed interest rate and pay a fixed monthly payment over a pre-determined period of time. This is typically 60 months (5 years).
What refinancing involves is coming back to the negotiating table with the bank and negotiating better terms. What you get out of the new deal depends on how much of the current loan is outstanding, your credit rating, your financial standing and the trade value of the vehicle.
When should you refinance a vehicle?
People generally refinance their cars when their financial circumstances have changed or when the interest rate improves.
If you applied for car finance at a time when you weren’t in a good financial position or you didn’t have a healthy credit score, the chances are you weren’t offered a favourable interest rate. Once you’ve proven you’re a reliable borrower and your credit score improves, the banks may look on you more favourably and offer you a better interest rate.
Of course, it might be the right time when the South African economy improves and interest rates drop. A drop of 2 or 3 percentage points in the interest rate would be a big saving over a period of time. Why continue with the rate you were offered originally when you could capitalise on that saving?
Let’s look an example: (the figures are rounded off to make it easy to understand)
Your original loan was R380 000 and you were offered a 7% interest rate. The loan period was 60 months.
If you don’t refinance your car and keep things as they are, you will end up paying a total of R453 000 on the loan.
After a year of payments on this loan, your balance will have reduced to R320 000.
If you refinance your car and get a loan for the balance of R320 000 for the remaining 48 months and at a lower interest rate of 5%, you will end up paying a total of R354 000 on your refinance loan.
Combined with the amount of R61 000 you have already paid on your original loan, you will end up paying a total of R415 172 to finance your car to the end of the refinanced loan period.
That’s a saving of about R38 000.
Do you qualify for a refinance loan?
The interest rate a bank offers you is determined by two factors:
- your credit score
- your debt-to-income (DTI) ratio which is calculated by dividing your monthly income by your monthly debt payments
You are entitled to negotiate a better interest rate if your credit score improves and your DTI ratio decreases over the time you are making your current loan payments on your car.
If you weren’t offered the best interest rate on your vehicle loan first time round, it’s worth spending the time shopping around for a deal; either a better interest rate or a longer repayment period.
With an improved credit rating and decreased DTI ratio, other banks who turned you down originally may be more likely to come to the party on a better interest rate when you apply to refinance your vehicle.
The latter is particularly true if you were forced to finance your vehicle through a car dealership when you bought it. Car dealerships generally offer a higher interest rate to cover the risk and make money on the deal.
Should you negotiate a longer repayment period?
It’s not always possible to negotiate a lower interest rate when you refinance your vehicle but you should be able to negotiate terms on the repayment period. This also helps to reduce your monthly loan payments.
However, a longer repayment period is only really an option if you are battling to cover your monthly expenses each month. Bear in mind, the longer you take to pay off your car loan, the more it will cost you in the long run. This is because you are paying interest on the car loan over a longer period of time.
For real cost savings, the aim of a new loan is to pay it off in the same time frame as the old loan but at a lower interest rate.
When is it not a good idea to refinance your vehicle?
Refinancing your vehicle will not save you money if you have already paid off a large portion of your current loan. Banks generally load up the interest at the beginning of the loan period. This means you won’t save much on a new loan if you’ve reduced the balance considerably on the old loan. The longer you wait to refinance your vehicle, the less you’ll save on interest.
Another factor to consider is the age of the vehicle and how much mileage it has on the clock. You’re unlikely to negotiate a better interest deal on an older model with high mileage because the car’s trade value does not make it a worthwhile deal for the bank. Cars depreciate quickly and banks generally only refinance cars that are ‘younger models’.
In fact, some banks won’t refinance a vehicle over a certain age or mileage because they run the risk of not getting their money back if they have to repossess it and sell it on.
One major consideration when thinking about refinancing your car is what impact it will have on your credit score. The moment you make a ‘hard inquiry’ at a bank for refinancing, your credit score will drop a few points.
Ironically, even though refinancing will save you money and provide some financial relief, it may negatively impact your credit score and your chances of applying for more credit in the future. This is because open positive accounts have a greater impact on your credit score than closed accounts. It’s recommended you hold off refinancing your vehicle if you’re applying for a mortgage.
How much does it cost to refinance a car?
There is a cost involved to refinancing your vehicle and you need to weigh up the fees against the benefits. There may be a pre-payment penalty charged for paying off your current car loan early. Some banks and car dealerships make you pay all of the interest owed for the negotiated repayment period in addition to the outstanding balance. This applies to loans with pre-computed interest.
Then, you have to look at what you’ll pay in refinance fees. This would include the re-registration fees. Refinancing can save you money in interest but you need to weigh up this saving against what it will cost you to refinance your vehicle.
What is cash-out refinancing?
Cash-out refinancing is something you’d do if you need a cash injection to cover a financial emergency or an unexpected expense. It involves replacing your current loan with a new one and borrowing extra cash against the value of your vehicle.
Cash-out financing is similar to the old ‘access bond’ where you could borrow money against the value of your property. The problem is cash-financing presents you with a short-term solution to a financial quandary but you put yourself at risk of owing more on your vehicle loan than your car is worth.
What is the difference between traditional refinance and cash-out refinance?
When you refinance your car in the traditional way, you take out a new loan to pay off your current loan which is the outstanding balance on your loan payment plan.
If you have a healthy credit score (which has improved since you obtained your original loan) and/or your financial standing has improved, you should be able to negotiate a lower interest rate on the new loan. You may also benefit financially if you are allowed to extend your loan period.
Cash-out refinancing involves taking out a new car loan to cover the remaining balance on your original loan but you also apply for an extra amount of money which the bank has no say over how it is spent. The extra cash allocated is calculated according to how much equity you have in the car. If approved, the extra cash is usually released as a lump sum.
Cash-out refinancing is often used for debt consolidation. In other words, using once source of credit to pay off high-interest debt from other sources such as your credit card. This option is only recommended if you can secure an interest rate for your refinance loan that is lower than the interest on say your credit card.
Using cash-out refinancing to consolidate debt is not recommended if you cannot get a better interest rate than you had on your original loan. You also need to ensure that the terms of the new loan do not mean you pay a higher monthly payment than you were paying previously. That’ll put you back in financial trouble.
What does it mean when you are ‘upside down on your car loan’?
The term ‘upside down’ or ‘underwater’ on your loan means you owe more on your vehicle than the vehicle is worth. This is a real risk of cash-out refinancing and is similar to borrowing against your home loan where what you eventually owe the bank is more than what someone will pay you for your home.
The reason you find yourself ‘upside down on your car loan’ is because cars depreciate, meaning they lose value over time. For example, if you owe R160 000 on your car loan but the most you are offered when you try to sell your car is R100 000, then you are in negative equity to the tune of R60 000.
You have two options if you find yourself ‘upside down’ or ‘underwater’. You can continue to make regular payments against the car loan while potentially going further into negative equity; or you can sell the car and take a hit on the loss.
The mistake that people fall into is buying a more expensive car because they are able to secure an affordable monthly payment only because they’ve stretched out the length of time they have to pay off the car loan. In this case, you’ve got the fancy car you’ve always dreamed but you’re stuck paying it off long after the value has significantly depreciated.
To stay ‘above water’, always ensure you refinance your car on better terms than the original car loan. If you are struggling to make ends meet financially now, you’re going to be in a far worse position if you increase your debt by borrowing more cash on a refinancing deal.
If you default on a traditional or cash-out refinance loan; your credit score drops significantly, the vehicle will be repossessed and you’re at risk of not getting credit again.
How do car balloon loans work?
Balloon loans are often offered as a refinancing option but the difference is a balloon loan includes lower monthly payments in exchange for a large one-time payment at the end of the loan period. Balloon loans are tempting but once again, reduced monthly payments are a short-term solution. The loan may be affordable to start with but will the large payment at the end turn you ‘upside down’ on your loan?
With a traditional vehicle loan, you make monthly payments based on the amount you borrow, the interest rate offered and the pre-determined repayment period. Over time, you chip away at the principle balance until the car is paid off.
With a balloon vehicle loan, you make lower monthly payments but the interest rate is usually higher and the length of time you have to pay off the vehicle is longer. This may seem ideal but you’re in for a big surprise at the end of the loan period when you’re wacked with a lump sum amount that you have to pay. This lump sum is known as a balloon payment.
You have a few options to get out of a balloon loan:
- see it through to the end, make the balloon payment and keep the car
- refinance the outstanding balance on the loan and keep the car
- trade in the car for a new one and secure a car loan with no surprises at the end of the payment period
- return the car to the dealership where it will be sold for its market value, and if the value of the car does not cover the balloon payment, you’ll have to pay the outstanding balance
Bear in mind, if you want to get out of the balloon loan and choose to trade in or return the vehicle to the dealership (lender), you may incur additional fees such as a disposition fee, excess mileage fee and excess wear-and-tear fee.
Be very careful when considering a balloon loan. As they say, if it looks too good to be true, it probably isn’t.
Step-by-step guide to refinancing your car
Now that you know more about how to refinance your car and you think it might be the right thing for you to do, these are the steps to follow to get the result you want:
Step 1 – Be 100% sure that vehicle refinancing is the right decision
Do your homework and find out what it will cost you to refinance your car. Find out if your current loan has a pre-payment penalty clause and how much it will cost you to pay off your car loan early. You also need to find out what it will cost you to re-register the vehicle and to transfer the title after securing the new loan.
Once you know what it will cost you to refinance your vehicle, weigh it up against how much you will benefit from the new loan.
Step 2 – Collect the documents you need to refinance your car
Any bank you approach to refinance your vehicle needs certain information and you can speed up the refinancing process by collecting this information and having it on hand before you apply for a new loan.
You need to provide:
- certified copy of proof of identity
- proof of income (3-months bank statement)
- proof of insurance
- information on your current loan (outstanding balance, interest rate and loan period)
- vehicle details (vehicle identification number/VIN, registration number etc.)
Step 3 – Find out if you qualify for refinancing
You have the luxury of time to shop around and find the best deal with regards to the interest rate and loan payment period that you qualify for. It’s a good idea to approach a few banks to get pre-qualified. This means making a ‘soft inquiry’ but not committing to the deal.
Pre-qualification does not guarantee you’ll be approved for a refinancing loan but it gives you an idea of where you stand before you commit to the process of applying for a refinance loan.
Step 4 –Apply for a vehicle refinance loan with a reputable bank
If you’ve done your homework, you’ve been pre-qualified for a new loan and have come to the decision that you want to apply for a vehicle refinance loan… then it’s time to apply for one.
You will complete a loan application through a bank and submit the documents they require. If your refinance loan is approved and the documents have been signed and processed, keep a copy of everything on record.
Bear in mind, that once you make a ‘hard inquiry’ through a bank for a vehicle refinancing, your application is flagged by the credit bureau. Your credit score will decrease slightly because refinancing does affect your points.
Step 5 – Pay off the balance of your original loan
The transition for your old loan to your new loan is usually handled by the bank but you need to make a point of checking the original loan has been paid up and your original loan account has been closed.
If you are refinancing your car through a new bank, it’s recommended you get confirmation from the bank you had your original loan with that the loan has indeed been paid in full and you are not liable for future payments.
Step 6 – Make your monthly payments on your new loan on time
This is obvious but be sure to start off on the right footing. Make your monthly payments on time and never miss a payment. This will ensure you maintain a strong and healthy credit score which improves your chances of applying for credit in the future.