Auto Loan Refinancing, A Lesser-Used Trick to Accelerate Savings

NEW YORK (MainStreet) — Earlier this month, Ryan Endean, a 34-year-old communications director at a Sacramento management firm, refinanced his auto loan in a move that he estimates will save him some $2,000 over the duration of the 72-month loan. Suddenly, a year into his loan, he's driving his certified pre-owned 2012 Nissan Altima a little more spiritedly on account of the savings.

But Endean's nimble maneuver – switching from his dealership's 6.99% interest rate to the more palatable 2.3% through Patelco Credit Union – is a lesser-practiced personal finance tactic. For consumers, the refi strategy usually calls to mind home mortgages, an especially popular move given the low interest rate environment in the wake of the Fed's quantitative easing plan. But auto loan refi gets forgotten: more than a quarter of Americans don't know this is an option, according to a survey from RateWatch, a premier banking data and analytics service owned by TheStreet. To boot, only 14.8% of respondents had refinanced their car loans – much to the detriment of Americans' wallets. And even though those ages 30 to 44, like Endean, were most likely to be aware of auto refinancing options, only 20% had taken advantage of them.

Long Loans Beget Refinancing

Standard auto loan refinance logic holds that a shorter-term loan will require higher monthly payments while incurring a lower interest rate. But with the way the economy has been, not as many people have as much cash to part with each month. As such, they'll take on longer loans.

"In today's market with the proliferation of long term loans, there are more lenders offering refinance by being able to extend the loan term in order to offer a lower monthly payment," said Melinda Zabritski, Experian's senior director of automotive finance.

In light of these long loans, consumers are looking for ways to keep interest rates lower.

"The current rates for auto-loans are at historical lows, and consumers are keeping vehicles longer than ever before," said Jesse Toprak, chief analyst at Cars.com. "As a result, we are seeing a larger number of consumers refinancing their loans. Having said that, refinancing an auto loan is still far less common than refinancing a mortgage."

That's unfortunate, because it's a relatively no-frills proposition, with some advantages in auto refinancing over other forms of refi.

"Unlike some mortgage loans, there is no pre-payment penalty for auto loans," said Toprak. "There are also no fees or closing costs for refinancing a car loan. Therefore, refinancing an auto loan with a lower rate can only help consumers save on interest charges."

It's a technique more consumers need to recognize as beneficial for their finances.

"Refinancing is one of many competitive forces in the auto financing marketplace that keeps auto financing rates low and affordable," said Paul Metrey, chief regulatory counsel for the National Automobile Dealers Association (NADA). "Consumers should be aware of this possibility, and the finance sources that provide refinancing have an incentive to make sure that they connect with consumers who may benefit from it."

Credit Score Is (Almost) Everything

There is such a range of interest rates out there – from around 2% to 8% - because loan rates depend on numerous factors like credit score, down payment and loan term.

Credit score is by far the most important factor; the lower your credit score, the higher the interest rate. A credit score higher than 720 can ensure the best available rates, but if your credit score is not up to snuff, you can rely on three tactics:

  • Make a high down-payment: Make sure you're not dipping into your emergency fund, but it can be advantageous to put down more cash upfront. "From the lender's perspective, it's all about managing risk," said Toprak. "The higher the down payment, the less risk they take. Less risk for the lender means lower rates for the borrower."
  • Get a manufacturers' low APR finance offer: Manufacturers are doling out low APR specials, including 0% financing offers. "The best part is consumers with less than perfect credit scores have a decent chance to qualify for many of these low rate offerings as the captive finance arms are motivated to help dealers sell as many cars as possible," said Toprak.
  • Head to a credit union: As Endean realized, credit unions can provide attractive rates on auto loans, and especially if you have a long-term relationship with the credit union, the lenders may be more likely to condone blemishes on credit history.

Caveat Refinancer

Still, be sure you don't tie yourself down to an expensive long-term loan thinking you can refinance.

"The best interest rates are often tied to the shorter loan periods, such as 36 months," said Philip Reed, senior consumer advice editor at Edmunds.com. "Other people, who are stretching to get into a car they really can't afford, will choose 72 month loans to get the car payments down. We think this is a mistake."

Instead, he says, consumers should try to finance a car for no more than five years with 20% down. For used cars, the recommended loan is three years at 10% down.

One of the most common reasons to refinance an auto loan is to lower the monthly payment. But don't fall into a lapse of judgment.

"You need to understand how the payment is being lowered," said Zabritski, of Experian. "If you keep the same term, but are able to obtain a lower rate, then refinancing can be a great option. However, consumers need to be aware that if the lower payment is simply the result of extending term, it can result in paying more interest over the life of the loan."

--Written by Ross Kenneth Urken for MainStreet

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