Refinancing auto loan may save you money, but do the math first

Knight Ridder News Service

Auto dealers are eager to lend you money these days. With a few minutes' search through the ads, you'll quickly find zero-percent loans for as long as 60 months.

Since these deals can't possibly last forever, it's enough to make you rush out to buy a new vehicle right now. That, of course, is the whole idea.

But what if you have a perfectly good vehicle that has many years of trouble-free service left? It's still sure to be worth less than any comparable new vehicle.

Even though it would be silly to buy a new car just to get a low-interest loan, it's still aggravating to look at the current ads when you're paying a higher rate on an older loan. What's the solution?

Simple: Refinance the older loan.

How do you do that? Very carefully, else it will cost you more to buy the car than it would have with the old loan.

Millions of Americans have refinanced their home mortgages over the past few years. Many would never think of refinancing their auto loan, but it's not particularly hard to do.

Imagine that a year ago you had taken out a five-year $25,000 auto loan charging 7 percent. You'd pay $4,702 in interest over five years.

After the first year, you'd have $20,673 of debt remaining. If you refinanced that with a four-year loan at 6 percent, you save about $10 a month — $458 in all.

Lots of lenders offer auto refinancing loans. Generally, interest rates on these loans fall within the range you'd pay for a loan to buy a used car.

Online lender peoplefirst.com currently offers 5.19 percent for 12- to 36-month auto refinancings, compared to 3.99 percent on new-vehicle loans, 4.19 percent for loans on used vehicles bought from dealers and 5.79 percent for used cars purchased from individuals. The rates are for borrowers with "excellent and substantial credit."

Lots of other lenders offer vehicle refinancing loans. Online, set your search engine to "auto loan refinancing." You might also try any lender that offers used car loans, such as your bank or credit union.

Before going this route, what do you need to consider?

• Make sure application fees and other charges won't eat up any savings you're hoping to realize.

• Make sure there won't be any fees or penalties charged to pay off your old loan early.

• Don't fall for a sales pitch that says you can "free-up cash" by extending the loan term to reduce your monthly payment.

In the example above, the new four-year loan would be paid off at the same time the original five-year loan would have been.

If the new loan instead had a five-year term, it would take six years in all to pay for the car. After the first year, monthly payments would drop from $495 to $400. But making an extra year's worth of interest payments, even at a lower rate, would mean paying $4,909 in interest rather than $4,702 under the old loan.

Finally, consider some alternatives.

One is to simply pay the old loan off early. That would eliminate all future interest payments.

If you have a car loan at 6 percent or 7 percent, paying it off would be like earning 6 percent or 7 percent, since you'd save that expense. Given that stocks have lost money for three years and that you'd be lucky to get 2 percent or 3 percent from a bank or bond, a 6 percent or 7 percent return looks pretty good — especially since it's guaranteed.

You could use the cash to invest in something else rather than pay off the car loan. But anything that might pay more than 6 percent or 7 percent is sure to be risky.

If you own a home, you might consider a home equity loan. To get one, the home must be worth more than the balance remaining on your mortgage. Most homeowners can get a federal income tax deduction on interest payments to a home equity loan.

Again, be sure you don't end up adding years to your interest payments. Get a loan with a fixed rate rather than a "line of credit" with a fluctuating rate that could rise, and make sure there's no fee or penalty for paying the loan off early.