In a time of tight household budgets, consumers are finding they can improve their monthly balance sheets with a little known type of loan: Refinancing an auto purchase.
With interest rates still low and loan money starting to flow again, it is possible to say goodbye and good riddance to high interest rates in your original contract. In some cases, this can deliver hundreds of dollars a year in savings. Best of all, the credit scores considered acceptable for a good rate have been trending downward, making the option viable for even more consumers. Especially good candidates for refinancing include those whose credit scores have risen since they took out their initial loan.
“If you have worked on your credit over time, and you have been able to go from a near-prime to a prime customer in a year or two, you would obviously warrant a better rate,” said Gary Pierce of LendingTree Autos, an online clearinghouse for consumer car loans.
Near-prime customers have credit scores in the mid-600s, and prime customers score at 680 or above. The scores are based on the so-called FICO score, a measure of creditworthiness developed during the 1950s and widely used in the financial industry.
With a credit score that’s risen from the low 600s to the high 600s, you could conceivably go from a nine percent rate down to four or five percent. A four-point decrease for a car valued at $20,000 could cut payments about $40 a month -- or $2,400 over a five-year contract. Savings would be even greater if you shortened the term of the loan, from 60 to 48 months, for example. The monthly payment might not go down in that case, but a car owner would save hundreds of dollars more on the total cost of financing.
Car Finance Tips
Another factor in favor of refinancing is that the financial climate is better than it was 18 months ago. So people are generally qualifying for lower interest rates than they did then. A score in the high 600s might get you a competitive interest rate of 5 percent today. At the depths of the financial crisis, you might have needed 720 for those rates. Other factors may come into play as well. Car buyers might have been saddled with an uneconomical loan when they first bought the vehicle. If they negotiated a great price on their car, the dealer may have managed to squeeze out a nice profit on the financing end.
“At the dealership, you are not necessarily going to have your cake and eat it too,” Pierce said. “You are not likely to get the best rate and the best price.”
Either way, the time is right to undo the damage. Traditional banks and online lenders are returning to the auto market, and they generally like refinancing customers, Pierce said, because these borrowers have a clear track record for lenders to evaluate. “They are considered good risks,” he said. “These are consumers who have proven they can make payments.”
Consumers are warming to the idea, too. About 20 to 25 percent of LendingTree auto loans are currently refinancing contracts, Pierce said. Capital One, one of the more active refinancing lenders, offers rates as low as 4.84 percent for vehicle refinancing and handles loans between $7,500 and $30,000, on vehicles no more than seven years old.
Some financial institutions have made refinancing as easy as possible, with online applications and answers back in as little as a day. Jeff Ostroff, the owner of the CarBuyingTips.com Web site, recommends credit unions if car owners have a hard time finding a bank willing to make the loan. But he warns that consumers should be wary of deals requiring extra payments. There shouldn’t be any penalties for prepayment either.
“You are going to get all these things in the mail from companies who say they can get you refinanced,” he said. “You want to make sure there are no upfront costs.”
But consumers still have to lay the groundwork. If your credit score was a problem when you bought your vehicle, you should pay special attention to paying bills on time for up to two years before trying to refinance. Obtaining a copy of your personal credit report -- before applying for refinancing -- is a necessity. This way you can be sure that it does not contain any errors and reflects any progress you have made on your creditworthiness.
When refinancing, you want to be careful not to get “upside-down” on the loan, Pierce said. “Upside-down” means you owe more on the principal of the loan than the vehicle is worth. Consumers might already be in that uncomfortable position if they put too little money down in the first place. To make matters worse, if you have chosen a 60- or 72-month contract, your car may depreciate faster than you are paying down the debt.
“If you do one of those long, stretched out loans, very little of your money goes against the principal at the start,” Ostroff said.
This comes back to bite you when the time comes to sell the car. Owners could end up in roughly the same shape as millions of U.S. homeowners who are currently underwater on their mortgages. In this case, to sell your vehicle you have to cover the difference between the amount owed and its market value. This sum can run into the thousands of dollars.
Ostroff recommends that consumers put 20 percent down when they make a vehicle purchase and keep the length of the contract as low as possible. “We tell people not to finance their car for more than 48 months,” he said.
Even if your credit prevents you from refinancing, Ostroff recommends doubling up on payments if you can afford to, or at least paying more than the minimum due. This will reduce the cost of financing the vehicle over the long haul.
It helps to keep in mind that even the most stylish, upscale luxury car is a liability on your personal balance sheet. “A car is a hugely depreciating asset,” Ostroff said. “You are down 20 to 30 percent in the first 12 months.”
But by managing the financing end well, you can make real assets -- like your savings account -- shine all that much brighter, which can lower the cost of owning a vehicle the next time around.