Refinancing your car

Love that shiny new car you just bought, but not the hefty interest rate you're paying? Refinancing may be the way to go.

Remember, even people with good credit get stuck paying high interest rates on auto loans.

That's because folks get so caught up in the excitement of buying a new car that they don't pay enough attention to the financing deal. They know they've got a nice new car and little else. Later, they're shocked at the sky-high financing rate they've agreed to pay.

And if you had credit problems in the past, refinancing might be a good option even a year or two into an original loan. Let's say that, because of damaged credit, you accepted an auto loan with an interest rate of 18 percent or more.

If you've built up job stability since the purchase and made loan payments on time for a year or more, you may qualify for a lower interest rate. It's worth checking out.

Inching a loan's interest rate down even a percentage point or two can save hundreds of dollars in interest and bring lower monthly payments. Say a borrower is paying 8.9 percent interest on a $10,000 loan over 60 months. The monthly payment is $207.10 and interest will total $2,426.74.

Drop the interest rate to 6.9 percent and the monthly payment dips to $197.54 and the interest to $1,853.05, a savings of $573.09.

This calculator will help you pinpoint just how much money you'll save by refinancing an auto loan to a lower interest rate. 

Since interest rates are still low, this is a great time to be in the hunt for a new and improved auto loan.

The first step to getting a better loan is taking a closer look at the loan you've already signed.

Does your current loan charge prepayment penalties? Some loans smack borrowers who pay off a loan early with fees ranging from $25 to $200. How is the rate on your current loan calculated? Is it calculated with simple interest? With a simple interest loan you're charged interest each day based on the balance you owe.

We'll discuss this more later, but for now keep in mind that refinancing makes the most sense and yields the biggest savings when a simple interest loan with no prepayment penalties is refinanced into a simple interest loan with a lower rate.

Where should you go for refinancing? Be sure to check out the deals available from local small banks and credit unions. This search engine from Bankrate.com will help you search for loan rates in your area.

Many small banks and credit unions send refinancing solicitations to recent car buyers. These offers may turn up in your mailbox just a few weeks after you've purchased a car. So be on the lookout.

You may also want to hop online. Carlender.com allows you to refinance your old loan through their Web site. Other sites offering competitive auto loans include E-Loan and PeopleFirst.com.

Be on the lookout for fees when shopping for an auto loan. States charge from $4 to $40 for changing the name of the lender on a car's title. Some lenders absorb that cost, others pass it on to customers. And some lenders charge processing fees. Be sure to ask.

Don't get surprised by the terms of your loan
But before you start shopping for a better loan, make sure your original loan is a simple interest loan. Most, but not all, auto loans are simple interest loans.

Some subprime lenders offer pre-computed loans instead. Once you sign on the dotted line for this type of loan, you're obligated to pay back principal plus the full amount of interest that will accrue over the entire term of the loan.

If you've signed on for a pre-computed loan, there's a good chance your lender will use the archaic and costly "Rule of 78s" formula to calculate a "rebate" of finance charges should you pay off a loan early or refinance. This rebate is actually a sneaky prepayment penalty.

For a borrower looking to end an auto loan early, there isn't a worse way a lender could calculate your payoff amount. Using the "Rule of 78s" method, your lender applies more of your previous payments toward interest and less of your previous payments toward principal.

Using "Rule of 78s," a lender typically collects three-quarters of a loan's interest in the first half of a loan's payments.

The earlier you try to pay off one of these loans the more you'll have to pay. The higher the interest rate, the more that payoff amount is going to hurt.

Buy here/pay here auto lots and lenders that specialize in offering loans to borrowers with badly damaged credit may offer these consumer-unfriendly loans. Folks with less-than-perfect credit should be on the lookout.

How can you tell if you've signed on for a pre-computed loan instead of a simple interest loan?

Check the front of a loan contract to see whether it allows a refund or rebate of interest. That's a sure sign you're about to sign on for a pre-computed loan.

And because it puts the most bucks in his pocket, there's a good chance that a lender offering a pre-computed loan will apply the Rule of 78s formula to all prepayments.

Flip over to the back of the contract and look under the section on prepayments for further details. Some contracts even mention Rule of 78s.

Avoid signing on to loans that apply the Rule of 78s formula to prepayments. If you've already signed on the dotted line, you're best bet is to make your payments as scheduled.

On your next auto loan, insist on a simple interest loan with no prepayment penalties.

In any case, to snap up a good financing deal, you'll want to make sure there are no unpleasant surprises on your credit report.

Thanks to a new law, everyone is entitled to a free copy of each of their three credit reports each year.

-- Updated : April 16, 2005