Refinancing your car or truck loan can save you money under the right circumstances. Before you refinance, it is important to educate yourself about loan concepts and terminology. Here is a comprehensive look at the vehicle refinancing process.
At the end of this article there is a glossary that helps explain important refinancing terminology.
Refinancing is paying off one loan by borrowing from another lender. The new lender mails you a check to pay off your old debt obligation. Then, under new terms, you begin making loan payments to the new lender.
First Things To Check Before Refinancing
Before you refinance, it is important to know the current value of your car. The best resource for this is Kelley Blue Book. The type and age of your vehicle can affect your refinancing options. Next, contact your current lender to find out exactly how much you owe on your existing auto loan.
The value of your vehicle might be less than what you owe because the total loan amount includes interest. This is called being “upside-down” on your loan. It could be because you are early in your loan term or because the value of your vehicle is losing value (depreciation) faster than you are paying it off. If this is the case, you may be limited in finding a lender to refinance your loan. If you are upside-down on your loan, it might be best to try to pay down the loan as soon as possible. In some cases, you might find lenders willing to refinance up to 105-110% of the value of your car. There are several trade-offs to refinancing your vehicle; below we highlight some important points to consider.
Your auto insurance premium can also be affected by refinancing. For example, you may or may not be required to purchase GAP insurance which would increase your insurance premium.
Finally, you should check your credit score before you decide to refinance (more on this later).
Understanding Interest Rates
The most important factor in refinancing is the interest rate. This is also referred to as the annual percentage rate or APR. The APR is based partially on the U.S. Prime Rate which is the interest rate that large commercial banks charge to their most creditworthy customers. The U.S. Prime Rate is published by the Wall Street Journal.
The other part of the APR is the margin. This is what the lending institution charges on top of the prime rate. As the name implies, the APR is the interest charged over an entire year, not per monthly payment. Even if the APR only goes down by 1%, it might worth refinancing.
Each APR is different and can be influenced by:
- The state you live in
- Vehicle year, make, model and style
- Your credit score
- Your employment history and income
- Total loan amount
- Original loan details
- Included fees
Fixed Vs. Variable Rate Loans
Fixed rate loans have an interest rate that never changes during the life of the loan. Variable rate loans have rates that fluctuate as the national economy changes, such as with changes in the U.S. Prime Rate. Variable rates are often lower when you take out the loan, but over time they can go higher than fixed rates. Fixed rate loans make it easier to manage your budget.
New Vs. Used Car Interest Rates
You might notice that new car interest rates are lower than used car, or refinanced rates. This is because auto manufacturers have special financing programs that often offer incentives to buy the rate down to 0% financing. Also, the higher intrinsic value of the new car makes interest rates lower. Finally, lenders assume that new car buyers are more creditworthy than used car buyers.
Loan Term And Timing Issues
The loan term is the time designated to pay off the loan. The longer the term, the lower the monthly payments, but you also end up paying more interest. When refinancing you should try to go for the shortest term possible.
When you refinance with a lower interest rate, your total loan amount will be smaller. In this case, consider maintaining the same monthly payment in order to pay off your loan faster and with less interest. In some cases, you might even be able to renegotiate with your current lender to reduce your loan term without any penalties or fees. An auto loan calculator may be useful in helping you compare savings from different refinance options.
If you are planning to sell your vehicle soon, refinancing may not be the best option. Any savings in interest might be lost if you end up paying an early termination fee.
Sources Of Auto Refinancing
Make sure you compare a variety of lenders before you select a provider. Don’t fill out a formal refinancing application right away. The reason for this is that your credit score might be affected if you make too many formal inquiries. First, just ask them about their current prime APR. Once you have a list of 3 or 4 lenders with low APRs, you can consider submitting formal refinancing applications.
Refinancing can come from a variety of sources such as:
- Auto dealers
- Credit unions
- Online banks/lenders
- Your current lender
Auto dealers typically have a higher margins or finance charges so this may not be the best place to seek refinancing.
Banks are one of the most common lenders. They can be local or national institutions, and for each there might be different advantages. One disadvantage of banks is that they may not offer subprime loans.
Credit unions are financial institutions typically serving a particular community or industry sector. Credit unions have members who are also the owners. When considering refinancing with a credit union, be sure to account for membership fees. The advantage of credit unions is that they frequently offer rates up to 1.5% lower than banks. Credit unions also provide other bank-like services such as credit cards and savings accounts.
There are also online banks and lending institutions that might offer competitive rates. Be careful though before you sign with an online lender in order to avoid the risk of fraud. If you have never heard of the lender, check out their reputation with the Better Business Bureau.
Many people don’t think to ask their current lender for a rate reduction. It never hurts to ask, and you might end up saving on transaction fees.
Auto Refinance Networks
There are online resources that can do the searching for you. A big advantage here is time savings. If you were to search on your own, you might have time to ask five or six lenders about their rates. For example, CARCHEX, has access to nearly one hundred lenders, and they compete to offer you the best loan option.
Beware Of Hidden Fees
On the surface, refinancing might seem like a good idea, especially with a low APR. Before you agree to refinance though, carefully check the terms. Your original lender might charge an early termination fee, and this is especially common with fixed term loans. These fees might also be referred to as penalty clauses, call provisions or closing fees.
Refinancing can also incur transaction fees on the new lender side which do not appear in the loan calculation or amortization table. All of these fees must be accounted for since they can wipe out any refinancing savings.
Refinance With Home Equity
Refinancing is replacing one loan with another, and this can happen in more than one way. Besides car-specific refinancing, you could consider taking out a home equity loan. This is borrowing against the equity that you have invested in your home. Interest rates are generally lower on home equity loans, and they are tax deductible. The downside on home equity loans are that fees are usually higher, and if you fail to pay the loan you could lose your home.
Credit Score Issues
Before you refinance, consider checking your credit score. The best places to get credit reports online are from:
Make sure you avoid imposter websites that offer you free credit checks. These sites might charge you hidden fees later or might even be involved in identity theft schemes. The Federal Trade Commission (FTC) provides useful information about credit reports.
Check your credit report carefully for errors. These can be simple mistakes such as misspelling of names or more serious things like credit listed on your report that does not exist or has been paid off.
The credit checks you make yourself do not affect your credit scores, but other types of inquiries can affect your score. For example, if you go to a bank and apply for refinance, this counts as a credit check. However, since 2004, federal regulations allow you to make multiple inquires related to a single transaction without additional impact on your credit score. These inquires must all be made within a 30 day period.
Online refinance services, like CARCHEX are especially useful here since they can solicit offers from many lenders. This process is completed rapidly, well within the 14 day limit so it is typically treated as a single credit inquiry.
One thing to avoid while considering vehicle refinancing is applying for or taking out another line of credit at the same time, like a new mortgage or credit card. This could substantially affect your credit score and increase the risk that you are denied refinancing.
Bad Credit And Auto Refinancing
Damaged credit does not necessarily exclude you from refinancing your vehicle, but it does limit your options. Banks often will refuse to give subprime loans, but other lenders are more flexible. According to the Automotive News, loan delinquency appears to be decreasing making auto loans more available, even for subprime borrowers.
If your credit score has improved since you took out your original auto loan, there is a good chance that you will qualify for a better APR if you refinance.
If you are having serious cash flow problems, refinancing might be an option in order to lower monthly payments by increasing the loan term. Be careful though because as time passes the value of your car goes down. This could mean you end up paying much more than your vehicle is worth due to high interest.
Finally, you might consider asking someone to co-sign your vehicle refinancing. A co-signer is a person with good credit who signs as the person responsible for covering the loan if you fail to pay.
Let’s review the auto refinancing process. If you follow this checklist, you can be confident about your vehicle refinance decision:
- Check the current value of your car versus what you owe. If you owe more than the value of the car you might not find a new lender.
- Check and review your credit score.
- Prepare a list of lenders to consult with, such as banks, credit unions, online lenders, and your current lender. Auto finance networks, like CARCHEX, can streamline this process.
- Consider home equity refinancing.
- Ask about all fees.
- Carefully compare all refinancing options.
Here is a brief glossary of terms that will help you better understand the refinance process. Terms are listed alphabetically:
- Amortization: The process of paying a loan through monthly payments, or installments. In the early part of the loan term, the majority of the payments go towards paying down interest. Most loans have amortization tables which show how much money goes toward paying principal and interest each month.
- Down Payment: A lump sum of cash you pay towards the purchase of a car or truck. The bigger the down payment, the lower the principal.
- Early Termination Fee: If you pay off a loan before the term ends or matures, you might be charged this fee.
- Interest: What you pay as a charge for borrowing, sometimes referred to as finance charges.
- Lienholder: The lender that provides your vehicle loan.
- Loan term: The amount of time designated to pay-off the loan. Usually ranges from 24 to 84 months.
- Prime loans: Given to borrowers with excellent credit.
- Principal: The amount you still owe on the loan for your vehicle. As you make payments your principal decreases.
- Refinance: Replacing an old debt obligation with a new debt obligation under new terms.
- Subprime loans: Made to borrowers with damaged credit. Subprime loans usually carry higher interest rates.
- U.S. Prime Rate: Interest rate which large commercial banks charge to their most creditworthy customers. Published in the Wall Street Journal.
Vehicle refinancing can be a way to save money or allow you to become a car owner more quickly. If you are well informed about the refinance process you can be certain that you will get the best possible deal.
About The Author
Joe Campanella is the EVP of Business Development for CARCHEX and oversees partner relationships. Joe possesses 12+ years of experience building sales/customer service teams and securing strategic partnerships. He is a sports enthusiast who enjoys mountain biking, surfing and snowboarding in his spare time.
Published in CARCHEX Auto Finance Resources by CARCHEX on November 28, 2014