Refinancing Your Auto Loan
Unlike the constant clatter of television pitches that are advising you to refinance your mortgage, you don't hear much about refinancing auto loans. But when interest rates decline, auto refinancing can save sizable sums of money under the right conditions.
Ed Powell, chief consumer officer at LendingTree.com, says that it's important to remember that consumers still have good opportunities to improve their auto loan terms via refinancing in any rate environment.
|Auto Loan Savings|
|In August 2008, average new-car rates were a little more than refinancing rates.|
|Loan Type||Interest Rate|
Source: Bank Rate Monitor
Refinancing isn't for everyone, though. If you bought a car in the last few years and got a promotional loan with 0 percent, 1.9 percent or 2.9 percent financing from the automaker, you have little motivation to refinance your vehicle at a rate of 6 percent to 7 percent. On the other hand, if you have an auto loan of 7 percent or higher, refinancing is worth a look.
Refinancing may not reduce your monthly payment dramatically, but total interest savings may reach $500 to $1,000 or more over the life of the loan. Use our payment calculators to compare various refinance options and gauge possible savings.
If you have poor credit, refinancing might save you even more money — if you can get approved. So-called "subprime" borrowers with bad credit often have car loans with interest rates of 15 percent, 20 percent or more. If you're in that predicament but your credit is clearly improving — say you have a better job and have paid your bills on time for the last two years — check out your refinancing options.
If you're considering refinancing, keep these 10 tips in mind before making a decision:
- Avoid prepayment penalties: Before you set out to refinance your car loan, make sure it doesn't carry a large prepayment penalty. Such clauses are increasingly rare, but if you will be penalized, it may nullify your refinancing advantage.
- Shop lenders: Nearly all banks and credit unions that make auto loans will also refinance — though the manufacturer's finance arm like General Motors Acceptance Corp. and Ford Motor Credit do not offer refinancing. Check local lenders, especially if you belong to a credit union through your company, union or professional association.
- Shop online: Increasingly, consumers are able to check online sources for financing options. Online finance sites are an especially easy way to refinance an auto loan; Capital One Auto Finance is one of the biggest of these online lenders. Unlike the past, these sites will consider refinancing to consumers who have mediocre or poor credit if there have been signs of improvement.
Other online refinancing options include LendingTree.com and E-Loan.com. LendingTree will give you competing bids on a refinance loan from participating banks and online lenders (often including Capital One). When you apply for refinancing through these online sites during business hours, you usually get a reply within an hour.
- Paying it off: If you are approved for refinancing, you pay off your old loan directly to the lender — not through the dealership where you bought the car. The address and phone number will be on your payment book or monthly statement. If you originally financed through the dealer, then you'd just send the payoff check you received from your refinance lender, say, to GMAC or to the bank that holds your old loan.
- Processing fees: In general, refinancing an auto loan carries fewer fees than refinancing a mortgage. It's common for you to owe only the $10 to $40 charge applied by your state for changing the name of the lender on your car's title.
- Extending the term length: If you aren't in real credit trouble but need some relief from the size of your payments, you may be able to cut that monthly bill by extending the term of the refinancing beyond that of the old loan. Some credit unions even report refinancing loans from borrowers who took out zero-percent deals from auto manufacturers. Those offers are primarily available on two- or three-year loans, and borrowers may find the payments burdensome on such a short term — even with no interest costs.
- However ... : Be careful when adopting a tactic of a lengthened loan for lower payments. While it can work in some circumstances, the longer payoff period may keep you from getting your next new car (or a newer used car) as soon as you would like.
- Home equity option: Because of their tax breaks and their structure, home equity loans can be a good refinancing option. If you own a house and have either no mortgage or one that is well paid down, consider this alternative. "Because home equity loans and lines of credit are structured with 10-year or 15-year payoff periods, the monthly payments are far lower than the typical, much shorter auto loan," explains Keith Gumbinger of HSH Associates, a publisher of consumer loan information.
- Beware balloon payments: Be doubly cautious on extending the payment period if you are using a home equity loan or line of credit. Some of these have payments that cover only the interest, and they don't pay down on the principal. You could theoretically make payments for 10 years and wind up owing a nasty balloon payment for the entire principal.
- Pre-computed loans: Make sure the loan you're paying off is a simple interest loan. Though increasingly rare, you may have signed up for a pre-computed loan. With these loans, you're obligated to pay back the principal plus the full amount of interest that will accrue over the entire term of the loan, regardless of early payoff. If you financed your vehicle from a used-car lot, this could be a possibility.
If you do have a pre-computed loan, make sure to insist on a simple interest loan with no prepayment penalties on your next vehicle purchase.