If you're a regular reader of our Interest Rate Roundup, you know that auto loan rate averages are pretty low right now. But when I dig a little deeper into the massive amount of data that Bankrate gathers every week, I see individual banks offering even lower rates that may put the auto loan rates you could find a couple of years ago to shame.
But when does an auto loan refinance make sense, and when does it makes sense to just leave well enough alone?
I posed that question to Greg McBride, Bankrate's senior financial analyst, and he homed in on two main conditions your new loan will have to meet to make a refi worthwhile:
- Get a much lower rate on your new loan. Because auto loans are generally smaller and shorter term than their mortgage counterparts, you need a bigger rate drop to notice a significant difference in your monthly payment.
McBride gives the example of a person with dinged-up credit who gets a $20,000 car loan with a 5-year term at 10 percent interest, giving her a monthly payment of around $425 a month.
After two years, her credit has improved, rates have gone down, and she's able to get a 3 year-used card loan with an 8 percent rate. That's two full points off her interest rate, and she's still stuck with a $412 a month car payment, saving her less than $500 over the remaining 3 years of the loan term.
On the other hand, if she can find a used car loan at 6 percent, she'll see her monthly car payment go down to about $400 a month, a savings of $25 a month and about $900 over 3 years.
Fortunately, says McBride, rates attractive enough to make a refi worth it are out there if you can qualify and are willing to shop around.
"There are some phenomenal rates out there," says McBride. "Three percent, 4 percent on new car loans, sub-5 percent on used-car loans."
If you're wondering where to start, McBride says, most of the best rates right now are at the big regional and national banks, which is somewhat surprising given that local banks and credit unions have often offered the best rates on such loans.
- Avoid extending the loan term with the refinance. Extending your loan term is an easy way to reduce monthly payments, but in this case, it's not a great financial decision, says McBride. Even if you get a significantly lower interest rate, you could end up paying more total interest if you decide to go for a longer term. Take the example above. If you plug that sweet 6 percent refinance into Bankrate's auto loan calculator, you'll end up paying $1,253.60 worth of interest over the 3 years of the refinance loan. But if you extend that refinance out to 6 years, that interest total goes up to $2,544.97, wiping out all your savings and putting you in a deeper hole.
One more potential barrier to an auto refinance is qualifying in the first place, especially if you didn't put much down on the car to begin with. That's because if you owe more on the original loan than your car is now worth ("upside down" or "underwater" in the parlance of our times), you'll have a hard time finding a bank willing to lend you money, says McBride.
"Put yourself in the lender's shoes," says McBride. "Who's going to lend you $25,000 on an asset that's worth $20,000 and falling?"