Although plunging interest rates have sparked a new wave of refinancing for home mortgages, when it comes to auto loans, a do-over is possible but not nearly as attractive. Here’s why…
Refinance rates for your aging vehicle generally are higher than new-vehicle loan rates. The average rate for refinancing recently was 5.3% versus below 4.8% for a new-vehicle loan. That’s because your vehicle serves as “collateral” when you get an auto loan, and if you’re refinancing, what is now a used car is less valuable. Lenders insist on higher rates to compensate for that less valuable collateral.
Lowering interest rates slightly produces surprisingly little savings. With a mortgage, lowering your rate by one percentage point can save you thousands of dollars—but that’s because mortgages are very large and extend for decades. Auto loans are shorter and smaller, dramatically reducing savings. Example: Each quarter percentage point that you lower the rate on a $25,000 four-year auto loan cuts the monthly payment by only about $3. With a four-year loan, that’s a total savings of less than $150 per quarter percentage point.
Refinancing a loan often extends the loan period. If you have just two years left on your loan and you refinance with a new four-year loan, you will lower your monthly payments, but you will have to make those payments for two extra years. That means you end up paying more in total.
What to do: Refinance only if it reduces your rate by several percentage points without extending the loan term. This is likely to be the case only if there’s at least three years left on your loan and your credit score has improved significantly since you took out the original loan (and/or if you failed to shop around before signing that initial loan and got a bad deal).
Shop around to compare refinance rates and fees at various credit unions, local banks and national banks. Also, read your current loan agreement to confirm that refinancing will not trigger a prepayment penalty.