Is It Time to Refinance Your Auto Loan?

The COVID-19 related economic crisis has driven many Americans to take a closer look at all of their outstanding bills, including auto loans. According to an Experian study, over 80% of new car purchases and 55% of used car purchases are financed. Nationally, that’s a total of over $1.7 trillion in outstanding auto loan debt as of the first quarter of 2019. The average interest rate on a new car loan is about 5% for those with credit scores over 700, and over 10% for those with lower credit scores.

With the federal funds rate hovering just above zero, interest rates are near all-time lows. But at the same time, economic uncertainty has led the financial sector to tighten restrictions on auto lending. It all adds up to a good question for those of us with a car loan: Can I refinance and save on monthly payments or overall loan costs?

Four Reasons To Consider A Refinance

1. Your credit score has improved since you purchased or financed your car. Interest rates for new and used car loans are heavily tied to credit score, so if your score has improved significantly, it could mean lower interest rate options are available.
2. Your car was financed through the dealership. Dealers make most of their money on financing packages and vehicle warranties, as the profit margin on the vehicle itself is only 2.2%. When you finance a car loan through the dealer, the dealer adds up to 3 percentage points to the rate they get from the lender. This means, your interest rate is higher than if you directly financed through a bank, credit union or other lending institution.
3. You’re struggling to make payments. Whether you went premium or practical, making a car payment can be a challenge if you’ve lost income or you've seen a rise in other expenses. Refinancing into a longer term car loan will increase your total car payments, but reduce your monthly bill. If that’s the difference between making those payments on-time or not, it’s probably worth it to protect your credit score.
4. You took out an auto loan with long payment terms. On the flip side of the last point, you may have an opportunity to lower your interest rate and shorten your term. For the first half of 2019, 70% of car loans had 6 or 7 year payment terms. Longer terms make for lower monthly payments, and help make a purchase viable for consumers, but they also translate to paying more for the car itself. If you can achieve an interest rate reduction, it may make a higher monthly payment more palatable, and the shorter-term loan can produce significant total savings.

Three Reasons Not To Refinance

1. Your car is worth less than you owe on the loan. You can check the value of your car with Kelly Blue Book. In general, Experian reports that a car must be worth more than the amount you still owe on it for a bank or financial institution to refinance it. Used cars are more likely than new cars to not meet this requirement.
2. You can’t afford, or don’t want to consider, an upfront payment. Due to the financial crisis caused by COVID-19, lenders are tightening standards to protect themselves from consumers who may lose jobs down the road and have trouble paying off their loans. As a result, some institutions are both lending less money in relation to a car’s value, and requiring a larger down payment. For borrowers with lower credit scores, lower loan limits and higher interest rates are likely.
3. You have a prepayment penalty. If your auto loan has a penalty for prepayment, you have to weigh that cost against your refinance savings to make an economically sound decision.

Whether or not you are eligible to refinance, if you're in danger of missing or making late payments many lenders are offering deferred payment options (be sure to check the terms) while others are open to discussing alternative or flexible payment arrangements.

Taking Action

If you’re ready to refinance, it’s time to start shopping lenders. Credit unions, banks, and other financial institutions are all viable options. There are also technology companies who offer aggregation and search options. The best lender for you is wherever you can find the best terms. We’ve partnered with Motorefi, an online aggregation service that offers benefits to borrowers that align with our mission. With Motorefi, you can search multiple lenders and compare refinance options, without any credit impact.

If you have an account with a credit union or small bank, you may want to inquire about special terms that may be available to you if your loan is connected to your existing account.

When comparing rates, remember to look at the interest rate, term length, potential fees and reviews or recommendations (especially for online lenders). Second, remember that credit inquiries affect your credit score, so if you're anticipating multiple hard credit checks from loan shopping, try and fit them all into a 45-day period to minimize the negative affect on your credit score.

Our mission is to empower Americans with personalized data and unbiased advice so they can make better financial decisions. Personal finances are personal – a complex web of factors made all the more complicated when economic uncertainty strikes. We're here to answer questions and provide guidance. Email us at hello@ownup.com.