What to Consider Before Refinancing Your Car Loan
By: Jeff Brown

NEW YORK (MainStreet) – Rising gas prices are pretty hard to avoid, but many drivers are finding another way to trim the costs of car ownership: by refinancing to cut interest rates and payments.

Growing numbers of drivers are refinancing to benefit from today’s unexpectedly low auto loan rates, according to a survey by SmartMoney. A car owner can also benefit if his or her credit rating has improved since the old loan was taken out, allowing him or her to get a new loan at the lower rate offered to borrowers deemed less risky. If you have paid down your debts, caught up with late payments on credit cards or other loans, or seen your household income grow, it may well be worth looking into refinancing.

Refinancing a car loan is typically much easier than refinancing a mortgage, taking an hour or two instead of weeks. With an auto loan, there may be little or no application fee, and there is no title insurance or other serious closing costs, just a minor title transfer fee. While it can take years for a mortgage refinance to pay for itself, a new vehicle loan at a lower rate can start producing savings right away. (Use the sbup Auto Loan Calculator to figure how much.)

Still, there are a number of issues to consider.

As with any refinancing situation, the borrower should be careful not to wipe out the savings by extending the loan term. If you have just two years left on the old loan, paying it off with a new five-year loan could actually increase your costs by adding three years of interest payments.

Borrowers with spare cash should also consider a “cash-in” refinancing. If you owe $15,000, you could use $5,000 in cash to reduce the new loan to $10,000. Assuming the new loan charged 6%, this would be like earning 6% on your $5,000, a pretty good yield compared to bank savings, bonds and money markets.

Another option is a home equity line of credit, many of which offer introductory rates of just more than 3%. After the initial period, typically one to six months, the rate will adjust monthly by adding a “margin,” or set number of percentage points, to the prime rate. With a prime currently at 3.25%, a borrower with good credit might get a two-point margin for a rate of 5.25% after the introductory period.

This is better than the 7% or more you’d pay with a home equity installment loan, which has a fixed rate for the life of the loan. But with the HELOC there’s always a risk the rate could go up. A HELOC would be best for the driver who wants to benefit from today’s low rates and has cash available to pay the loan off if rates jump. Given the Federal Reserve’s commitment to keep short-term rates low for the next couple of years, a HELOC might produce real savings at minimal risk.

If you choose to refinance through a car dealer, bank or credit union, keep in mind that the refinancing rate may be somewhere between the new car rate and the used car rate. Start your shopping by talking to your current lender, then use the search tool to find lenders offering appealing rates. You’ll have to talk to them to find the exact rates for refinancing.

Even if you have imperfect credit, a good car loan may still be within reach. Find out why in our look at Why Weak Credit Won’t Kill a Car Loan.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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