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Don’t Bother With Car Loan Refinance

By sbup Staff

With mortgage rates at historic lows, consumers have refinancing fever. But not all loans need to be refinanced: Refinancing a mortgage may save homeowners thousands of dollars, but it almost never makes sense to refinance a car loan.

Here’s why. Car loans typically last three to five years -- any longer and you’re significantly increasing the cost of your car. Meanwhile, mortgages are generally in the 15- to 30-year range. With so little time for interest to compound on a car loan, a drop in interest rates only amounts to a few hundred dollars of interest savings over the life of your car loan.

Let's say you are two years into paying off a 60-month car loan with an interest rate of 7%. You bought a $15,000 Ford (Stock ticker: F) Focus with $1,500 down payment, no fees or trade in, and 5% sales tax. Money is tight and your $282 monthly car payments are a prime target for creating a little extra breathing room in your budget. So you head to manybanking.com to shop around for the best rates on car loans. There you find rate offers on 36-month loans from Bank of America (Stock quote: BAC) and Capital One (Stock quote: COF) with interest rates of 4.49% and 5.04%, respectively.

Keep in mind that replacing the three years remaining on your current loan with a comparably termed loan will keep extra years from being tacked on to your loan -- ultimately saving you money in the long run. The same concept applies to refinancing a mortgage.

After two years of payments on your initial auto loan, you still owe $9,221. (You can figure out how much balance is left on your car loan by contacting your lender or by clicking on the "view report" button on manybanking.com's Auto Loan calculator, after entering the details of your loan.) A $9,221 balance on a 36-month loan with a rate of 4.49% has a monthly payment of $274 -- that's just an extra $8 per month for your budget. And while $8 a month might help, it's probably not worth the time required to apply for a new loan.

Besides, you may not be able to refinance the full balance of your existing loan. Cars depreciate quickly once they are driven off the lot. In the first two years, your Ford Focus might have lost up to 35% of its value (20% in the first year, and 15% per year after that is considered average in the industry). With that in mind, your car may only be worth $9,750. The Bank of America loan has a loan-to-value ratio of 90%, meaning you would have to come up with an extra $446 in cash to pay the $9,221principal down to $8,775 ($9,750 x 90% = $8,775).

Paying almost $500 up front for just $22 extra a month (the lower loan amount drops your new monthly payments down to $260) doesn't really seem worth it in the end.

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