Trading in your auto loan for shiny, new financing

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Love that shiny new car but not the hefty interest rate? Refinancing may be the way to go.

Inching down a loan’s interest rate even a percentage point or two, say from 10.9 percent to 8.9 percent, can save hundreds of dollars in interest and bring lower monthly payments.

Good credit may not mean good rates
Lots of people with good credit get caught paying high interest rates.

“A lot of times they get hooked with a rate. They get caught up in the moment when buying the car,” said Dave Zeller, president of online auto lender
PeopleFirst Finance. “We see people with outstanding credit with 12 or 13 percent rates.”

Impulse shoppers are particularly susceptible.

“They fall in love with the car,” Zeller said. “And when the dealer says ‘This is the monthly payment.’ They say ‘fine.’ “

Know what you have

Before shopping around for a better auto loan, take a close look at the rate on the current loan. Is it calculated with simple interest? Some loans are designed so that a majority of the interest and very little principal is paid in the first year. This means a year into the loan a borrower still has a principal balance close to the original loan amount. Before refinancing, someone with this type of loan needs to consider whether a lower interest rate is worth paying even more total interest.

Many loans also carry prepayment penalties ranging from $25 to $200. A steep prepayment penalty could wipe out any gains from refinancing, especially if a customer is already a year or two into the current loan.

Refinancing carries the most benefit when a simple-interest loan with no prepayment penalties is refinanced into a simple-interest loan with a lower rate.

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.

“We’ve had members refinance for $2 a month savings just because it would lower the interest over the life of the loan,” said Tom Kane, executive vice president of lending for
CUNA Credit Union in Madison, Wis.

Credit union and small bank offers

Like many credit unions and smaller banks, CUNA Credit Union hawks low rates by sending refinancing solicitations to new car buyers.

“It’s quite common in our market for financial institutions to try to steal that business back and forth,” Kane said.

At CUNA Credit Union, a customer qualifies for a new car loan rate ranging from 7.15 percent to 10.75 percent if the loan is refinanced within three months of the car’s purchase. Some lenders allow new car loan rates within six months of purchase.

Many loan applications can be completed in 10 minutes or less. Some lenders give approval within 15 minutes. Others take an hour or a day.

“It’s easy. The only pain is the phone call and going into the office and signing the papers,” Kane said. “It’s a time cost. It’s a very easy way to save money.”

However, there are a few fees associated with refinancing. States charge from $4 to $40 for changing the name of the lender on a car’s title. Some lenders absorb the cost of title fees. Others pass them on to customers. And some lenders charge processing fees.

Refinancing can be useful

For some people, including those who had credit problems and accepted a loan at 18 percent or higher, refinancing might be a good option even a year or two into the original loan. If they have built up job stability since the purchase, and made their loan payments on time for a year, they may qualify for a lower interest rate from a subprime auto lender such as
Household Automotive Finance Corp.

Also, many people struggling to pay bills may see refinancing as a way to lower their monthly payments and lengthen the loan’s term. The trouble with this tactic is that the customer will end up paying more in interest. However, coughing up more interest on a loan beats falling behind on bills.

“If someone’s finances become tighter, extending the loan could be helpful if it allows them to stay current on their bills as opposed to falling behind,” said Mike Kidwell, vice president of
Debt Counselors of America. “When things get better they can pay more than the minimum.”

If someone is already behind on bills, refinancing a lower rate on an auto loan is unlikely.

“They’re going to check your credit. If your debt/income ratio is all out of line, they’re going to know,” Kidwell said. “In that situation, people have to make the decision if they want to keep the car or sell it to get away from a high monthly payment.”