Pros & Cons of Auto Refinancing
The interest rate you paid when you purchased your vehicle may have been good at that time, but it may be a mediocre rate now. Interest rates on auto loans fluctuate as much as the stock market, leaving some consumers confused about whether to stick with their current loan or examine a refinancing option.
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Money Savings
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Refinancing an auto loan may save you money. An interest rate decrease of just one percent would equal a savings of about $500 in total interest paid (depending on your principal balance). If the rate can be lowered by at least this much, it is generally a good idea to examine refinancing options.
Total interest paid is this best guide to determining whether to refinance; however, other situations may arise. If your monthly budget is a wreck and you need to lower your payments, refinancing may be an option. Lengthening your term will cost you in the end, but this refinancing option can lower your monthly payment and make room for other expenses.
The Cash Out
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If you are having cash-flow problems, a cash-out on your auto loan can be a way to get your finances back on track. A cash-out requires equity in your vehicle (it is worth more than what you owe). The lender you refinance with will loan you the amount of the vehicle book value (NADA is most common with lenders), and pay off any other balance you may have on the loan, returning the difference to you.
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Starting Over
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In most cases, refinancing an auto loan requires starting over. Most interest is front-loaded, meaning the first couple of years of an auto loan you are primarily paying interest charges. Lenders compute interest on auto loans this way because consumers tend to trade-out of their vehicles often, costing the lender thousands of dollars in finance charges during the course of the loan.
If you have had your auto loan for less than a couple of years, chances are that you have paid very little toward principal. Refinancing would require you start over, sometimes just as you knock out most of the interest.
Negative Equity
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Refinancing will increase the chances of having negative equity. Negative equity (often called being upside-down) happens because vehicles tend to depreciate faster than we can get them paid for. Unless you are refinancing for a shorter term, the chances are likely that you will have negative equity on your auto loan.
Who Can Refinance?
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Refinancing is not for everyone. The credit criterion is usually tougher for refinancing than it is for purchasing. Refinancing is also difficult if you do not have equity in your vehicle. A recent study by Benchmark Consulting found that more than 25 percent of car loans in America have negative equity, an average of $4,250 worth of it. Unless you put a large down payment on your vehicle or traded in a paid-for car, it may be difficult to refinance.
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