EchoBay Expert: I'd like to figure out if refinancing my car loan will save me money or cost me more in interest payments over the next few years vs. my current auto loan. What are the general guidelines for deciding if auto refinancing is worthwhile?
Loyal Reader: There are several issues to consider when you are trying to figure out if auto refinancing is best for you. If you plan to increase the term of your loan or refinance again for your original term, you could be looking at paying a great deal more in interest even if you are refinancing for a lower rate.
Many try to lower their payments this way but if possible, you should keep your payments the same and refinance for a shorter term with a lower interest rate. This will ensure you save money.
Second, how close are you to paying off your loan? With auto loans, the majority of the interest is paid in the beginning of the loans. Once you pass the half-way point on your loan, you should give some thought as to whether the savings is significant enough to refinance.
Third, can you refinance your car for a lower interest rate? Interest rates on used car loans are generally higher than new car loans. It is possible that you would increase your interest rate when you refinance simply because the car is now considered used.
Fourth, how is your credit now compared to when you took out your original loan? If your credit has significantly improved, it could be worth your while to investigate auto refinancing. An improved credit rating could lower your interest rate significantly. Rather than a traditional auto refinance loan, if you are a homeowner, you may want to consider a home equity loan.
This can offer you a low interest rate as well as the ability to write off the interest paid on your taxes. The final consideration is if your loan is a simple interest loan or a pre-computed loan. It is not always beneficial to pay off a pre-computed loan because you pay significant amounts of interest early in the loan term.
If your lender is applying the Rule of 78s, it could add up to even more interest that is paid. If you financed through a traditional lender, it is likely that you have a simple interest loan. However, finance companies do favor pre-computed loans as they are able to collect a majority of the interest very early in the loan term.