Is refinancing your car loan worth it?
Auto sales keep setting records, with 2015 seeing the highest number of trucks and cars ever sold (more than 17 million). This is partly because borrowing money to buy cars keeps getting easier. Longer terms, lower credit score requirements, and persistently low interest rates keep enticing Americans to buy new wheels.
Most of those cars are financed — about 85% are purchased with a loan, or leased. As a result, the total outstanding balance on car loans in America is also higher than ever before (and higher than the total outstanding credit card balance in the nation), at more than $1 trillion, according to TransUnion.
A simple phone call to a lender could ease some of the monthly budget pain caused by that $1 trillion. Just as home loans can be refinanced, auto loans can be refinanced, too. In fact, getting a better deal on your old car loan is a lot easier than refinancing a mortgage. While it may not be worth the trouble for consumers with good credit who got decent financing when they bought their car, other drivers could see big savings by refinancing.
Why this is happening
To keep the factories churning out record numbers of new cars, automakers keep stretching the limits of new car loans. More than 1 out of 5 new car loans now go to subprime borrowers. Also, the old 5-year, 60-month auto loan standard is so 20th Century. Ford recently joined several of its competitors in offering an 84-month loan to dealers around the country. In fact, loans lasting 73-84 months now make up 29% of the market. (Experian reports that the average subprime new car loan lasts 72 months.)
Longer loans mean lower monthly payments, of course, but also higher borrowing costs. Because subprime loan rates often come with double-digit interest rates, the financing costs can really add up. Seven years is a long time to be paying that much to borrow money.
Here’s the good news: Auto loan refinancing loans are now available for around 3%, which is a far cry from the average rate for a subprime car loan right now of 10.4%.
Google “auto loan refinance,” and you’ll see banks are competing fairly heavily for business. Call the bank where you have your checking account; the bank will probably have a simple auto loan refinancing offer, which may not even include a fee.
How big the savings might be
A $20,000, 6-year car loan at a 10.4% rate equals monthly payments of about $375. After two years, the balance on the loan would be $14,657; but the consumer would still be facing $18,000 worth of payments ($375 for the next 48 months).
If the loan is refinanced at the point, the savings are dramatic. Payments would drop to $324 per month (more than $50 in savings!) and the total remaining payments drop to $15,552. That’s just about $2,500 over the life of the loan. Certainly well worth the call to a lender.
Granted, this scenario is for a nearly ideal auto loan refinancing candidate (this imaginary consumer went from subprime to prime borrowing status within 24 months), so it wouldn’t apply to everyone. It’s not impossible, but it’s not common.
Still, last year, Experian said there was $178 billion worth of outstanding subprime loans held by consumers. It’s a good idea to make a goal of reaching prime status. The ability to refinance into a much cheaper car loan can be a nice carrot to help inspire anyone to go through the process.
Now, let’s examine a consumer who might be tempted to refinance because she or he got a not-terribly-great-rate from their auto dealer. We’ll say this consumer borrowed $25,000 for seven years at a kind-of-ugly 4.5%. Those 3% refinance rates can sound attractive — and if we were talking about refinancing a home, a 1.5% rate drop would probably be worth it. But with a simpler, shorter car loan? Not so much.
The driver above would be facing 84 months of $348 payments. After two years, there would be $18,639 left on the loan. Refinancing that amount at 3% over the past 5 years of the loan would result in some savings — about $13 per month. That’s still about $780 over the life of the loan, but remember, that savings is spread over five years. Perhaps not worth the call.
When is it worth the time?
There are no solid rules, but consider this — for every $10,000 borrowed, a drop of 1 percentage point is worth about $5 per month over 48 months. Roughing out the subprime-to-prime example above: a 7% drop is worth $35 (times 1.5 because the balance is about $15,000) and there would be a bit more than $50 in monthly savings. But if the drop is from a 4% rate to a 3% rate, the savings probably wouldn’t be more than enough to buy you an extra tank of gas each year (depending on gas prices, of course).
But as the auto industry continues to encourage longer-term, higher-dollar-value car loans, the calculus toward auto loan refinances continues to tip in consumers’ favor, so it doesn’t hurt to ask.
If you’re thinking about taking out an auto loan to finance a car, it is smart to check your credit first, as a good credit score can help you qualify for better terms and conditions. You can see two of your credit scores for free each month on Credit.com. If you don’t like what you see, you can take steps to improve your credit score to help you prepare to buy your next car.
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