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Why You Shouldn't Refinance Your Auto Loan

NEW YORK (MainStreet)—Low interest rates are driving some consumers toward the option of refinancing their auto loans since many people are keeping their vehicles longer.

Refinancing the loan for your cars or trucks is a relatively easy process since the loans are for shorter periods and smaller amounts compared, say, mortgages.

Some consumers are considering the option so they can reduce their interest rate or the cost of borrowing while others want to slash their monthly payments, said Karl Brauer, senior director of insights for Kelley Blue Blue Book, the Irvine, Calif. provider of new and used car information.

Although interest rates have risen recently, the current rates are still "quite low" compared to rates from two to four years ago, he said.

"If a consumer got a car loan a few years ago--and assuming their credit rating is as good or better than it was back then--they can likely get a lower rate today," Brauer said.

If you bought your new or used car within the past year, refinancing is not likely to be a good option, he said.

"Since rates have gone up recently, compared to the historic lows they were at through early June, it might be difficult for a consumer to get a lower rate now if their existing car loan was established in the past year," he said. "Car loan rates are still very low, relatively speaking, even with the recent bump up in overall loan rates."

To ensure refinancing your loan is successful, consumers need be able to reduce their interest rates by 3 to 6% or avoid the option, said Greg McBride, a Bankrate senior financial analyst based in North Palm Beach, Fla.

"You need to reduce your interest rate in noticeable manner and move it by several percentage points in order to make a noticeable dent without stretching out the loan period," he said. "It needs to be a compelling difference."

Since auto loan rates have dropped to levels the market has never seen before, the average rate for used cars is 4.5% while the lowest are below 2.5%, McBride said.

In some cases, lowering your loan rate by 1% would save you only $12 a month since car loans are for shorter periods, enabling you to already pay a "good chunk of the principal," he said.

If refinancing leads you to stretch out your payment period, then skip the option, said Mackey McNeill, a Bellevue, Ky. CPA and financial planner. If your original loan was for 60 months or 5 years and you have had the car for two years, then you need to get a new loan for 36 months or 3 years when you refinance.

"One con would be anyone who finances for a longer term then they have left of their existing loan," he said. "With depreciation and everything else, it's easy to be upside down on a car and that is a sure way to do so."

If you bought a new car recently, refinancing is not likely to save you any money, McNeill said.

"In general, most auto manufacturers are financing vehicles for under 3% and even 0% is not uncommon," he said. "At that level of interest, there are probably few, if any refinance deals that would make sense to most consumers."

If your credit has improved since you purchased your car such as having a new job, refinancing can make sense for you.

"One pro might be for someone who experienced a lower credit rating at the time of purchase and is now in better fiscal shape and can qualify for a lower rate," McNeill said.

Refinancing your loan in order to pay off your debt sooner is a good option, said Don McClintic, home equity and direct lending manager SunTrust, which is based in Atlanta, Ga.

"You need to determine what you're trying to accomplish," he said. "Some consumers want to lower their monthly payment amount to improve their existing cash flow while other people want to pay off their loan and have ownership sooner or a combination of both. Consumers should have the loan structured to achieve their end goal."

Consumers who are able to reduce their monthly payments should put the extra income into a savings or investment account, said McClintic.

"If you take the $60 a month and save or invest it, you will have a nice nest egg," he said. "It's just having the discipline to do that and redeploying your savings."

Consumers should not focus only on finding a lower interest rate and also ask questions about other aspects of the loan, Brauer said. Check out the loan term and whether there are any fees or penalties such as a paying off the loan early or being late on a payment.

"The rate is only one element," he said. "Consumers that fixate on the loan rate might get burned by other aspects of the loan that they didn't fully investigate."

Getting your loan from a bank that does not have a relationship with the dealership can be advantageous and ensure you get a better rate, said Ted Sarenski, a Syracuse, N.Y. CPA and financial planner.

"When you purchase a car from a dealership, they will often do the financing with a bank they do business with where they get a piece of the financing as income to the dealership," he said. "In those cases, you may not be getting a good rate of interest. You may find a better rate by going to the bank where you have your checking account or mortgage with or a credit union."

If your credit has deteriorated since you purchased your car, refinancing is not an option, said McBride. Refinancing should not be considered if you plan to sell or trade your car off soon.

"Refinancing now is not going to make whole lot of sense," he said. "You're not going to accrue the full benefit."

--Written by Ellen Chang for MainStreet

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