Should You Refinance Your Car Loan?

The following was originally posted October 2, 2008 , updated 10/23/09.

Cutting out little luxuries like a morning latte or dinner at a restaurant only goes so far to reduce expenses. To really make an impact you've got to look at your current expenses with a new perspective. Like you car payments. When was the last time you looked at your payment? Have you ever even considered that you might be able to lower those payments? Chances are good that an autoloan refinance could give you some relief each month. But don’t just look at your monthly payment before deciding to refinance.

Refinancing for longer terms could end up costing even more over the life of the loan. Say for example you’ve got a $15,000 auto loan at 12% written for 60 months. Your current payment is $360 each month. The total amount you’ll pay when the loan is finished is $21,622. You’ve just completed the 2nd year of payments, so you’ve already paid 24 payments or $8,640. Your remaining balance is $12,982.

You refinance the loan at a lower rate of 8%. This time you’re refinancing the remaining balance of $12,982. If you choose another 60 month loan your monthly payment would be just $263.22—nearly a $100 savings in your monthly budget. That would definitely relieve the strain. But over the life of this loan you’d pay $15,793. Add that to the $8,640 you’ve already paid and you’ve spent $24,433 on a $15,000 car.

But what would happen if you were to refinance at the same 8% rate and shorten the terms to 48 months? You’re payment would be slightly lower than the original loan at $317. And at the end of the refinanced loan you would have paid $15,216. So again you’d be paying almost $3,000 more than the original loan.

Refinance at shorter terms—say another 3 years and you’re payments are higher than what you are currently paying--$407, but your total cost only goes down to $14,645. Add on the $8,640 you paid previously and you’ve spent $23,285.

So what you need to decide is which is more important. Paying less overall or reducing your monthly payment and paying a bit more in total? Does that $3,000 matter to you? Maybe you’d be better off investing that money? But then again, it’s not like you’ve got that cash lying around. If you do you shouldn’t be considering this scenario at all. Remember, the name of the game is to reduce debt.

How Long do You Need to be Employed to Get a Car Loan?

This question was recently posed to me by a reader. It's a good one and brings up a few topics. First off, every loan application asks for employment status and history.

I asked the Coors Credit Union lending manager to give a general comment and this is what she said, "There is no minimum to apply. However it is preferred that an applicant has at least 6 months employment history, again preferably at the same employer."

But, the answer also depends on your situation and your credit score. You probably are aware of how important a good credit score is for qualifying for a loan and for getting a good rate, but employment can subtly affect your loan as well. Generally, lenders like to see consistent employment history of two years, but that doesn't mean others can't get a loan.

First-time buyers can get a better rate by waiting until they've been at a job for six months. For many first-time buyers the biggest hurdle is credit history. Often they just don't have much. You can qualify for a better rate and begin to build your credit by finding a co-signer. The loan will be yours. You'll make the payments and build credit history. However, if you can't make the payments your co-signer will be liable. If payments aren't made both of your credit scores will suffer.

Lenders look at numbers to determine risk. The higher the risk the higher your interest rate. Two things determine the risk level:

1) credit score

2) debt-to-income ratio

In some cases, you may be asked to provide proof of income. For example, self-employed people may need to provide documentation of income.

It is not impossible for unemployed people to get a car loan, however, you cannot claim unemployment benefits as income.

One thing to keep in mind when buying your first car, or any car, is that you are not locked into the rate you get. After a year your credit score could improve and if you stay with the same job your employment history will be more secure. At this time you could refinance your loan for a lower rate and possibly drop the co-signer if you have one.

Before you co-sign a loan

A long, long time ago a certain relative (no names, you know who your are) asked me to co-sign an auto loan and I said, "no".

I felt cruel and heartless. This person was desperate. She needed a car to get to her job. But she didn't have a credit history and couldn't get a loan. There were tears, but no blame.
Why did I say no? Because I knew this person. I knew how badly she handled money. More than that I knew that I couldn't afford to take on another car payment, which might happen if (or more likely when) she defaulted on the loan.

As a loan co-signer you agree to ensure that the loan will be paid back. The lender doesn't really care who pays it, as long as it's paid. If the primary borrower defaults or skips town, you're likely to be held liable. Typically, the lender can come after you first, without trying to collect from the borrower. And so, you could:

• be required to pay late fees or attorney fees.
  have your wages garnished.
• lose any property you put up as collateral

Not only that but your credit score could be affected by the primary's default or late payments. And if you are planning on a purchase such as a house or car for yourself in the near future this co-signed loan will appear on your credit history.

Before you agree to co-sign on any loan review the situation.People only need a co-signer for one of two reasons: 1) they do not have a credit history, or 2) they have really poor credit.

If the person you know falls into the first reason think about how well you know them. The loan already creates a legal agreement that they are expected to make payments, but do you think they have the capacity to do so? Do they have a job? Do you have any reason at all not to trust them?

For wannabe borrowers who fall into the second category of poor credit, do you know how they got there? How long have you known them? Instinct should tell you if someone is a high-risk.

To protect yourself you can do what I did and just say, "no". Or, you could try asking the lender to write an agreement into the loan stating that you would only be responsible for the balance of the loan at time of any default. This could save you legal fees later.

Don't get me wrong. Co-signing isn't all bad. If you know someone who is young or recently divorced they may not have an adequate credit history. Your co-signing can help them begin to build credit--which is important as they continue in their life.

As for the one that I said "no" to--She got a car the old fashioned way. She continued to borrow a car to get to work then saved enough to buy a used car. It wasn't as pretty as the brand new car, but it worked great and I think it helped learn some financial discipline.

Credit unions have money to lend

My friend was shocked, "I just got my mortgage statement and they (the bank) lowered my home equity line of credit. How could they do that?" He's talking about the credit available. He's upset because he was planning to use the line this spring to make some home improvements. He couldn't understand why this happened when he's never even touched the loan in 5 years.

Well, that was about a month ago and lots more people have discovered their in the same spot as financial institutions tighten up lending. So what are you supposed to do if you've got good credit and a desire for a loan. Wasn't the financial bailout supposed to encourage lenders to give out money?

That was the theory and while nobody should have expected that bailout to turn things around immediately, consumers in search of loans are not seeing much change. And then there are credit unions.

Credit unions are waving their cash filled arms saying "we're here! we're here!" That's especially so when it comes to mortgages and home equity loans. That's because the majority of credit unions have been involved in the risky subprime mortgage mess.

As journalist Broderick Perkins tells it in Reality Times, an online real estate journal:

Credit unions didn't need a bail out during the Great Depression, they didn't need federal intervention during the Savings & Loan debacle and they don't need government assistance now.

Because of the cooperative structure of credit union there is little encouragement of excessive risk taking. As a result, credit unions experience extremely low net loss rates in general and even in current conditions. The conservative operating style of credit unions also explains why they remain very well capitalized today--thus ready to lend money now.

So if you're looking to purchase a home, take out a home equity loan or buy a car your credit union is ready and willing to lend. They'll also give you an honest loan that won't bite you later.

Could you cut your bills by refinancing your auto loan?

With prices in the stratosphere, cutting out little luxuries like a morning latte or dinner at a restaurant only goes so far, especially if you own an SUV or family minivan. Maybe you could refinance your auto loan? It certainly could give you some relief each month. But don’t just look at your monthly payment before deciding to refinance.

Refinancing for longer terms could end up costing even more over the life of the loan. Say for example you’ve got a $15,000 auto loan at 12% written for 60 months. Your current payment is $360 each month. The total amount you’ll pay when the loan is finished is $21,622. You’ve just completed the 2nd year of payments, so you’ve already paid 24 payments or $8,640. Your remaining balance is $12,982.

You refinance the loan at a lower rate of 8%. This time you’re refinancing the remaining balance of $12,982. If you choose another 60 month loan your monthly payment would be just $263.22—nearly a $100 savings in your monthly budget. That would definitely relieve the strain. But over the life of this loan you’d pay $15,793. Add that to the $8,640 you’ve already paid and you’ve spent $24,433 on a $15,000 car.

But what would happen if you were to refinance at the same 8% rate and shorten the terms to 48 months? You’re payment would be slightly lower than the original loan at $317. And at the end of the refinanced loan you would have paid $15,216. So again you’d be paying almost $3,000 more than the original loan.

Refinance at shorter terms—say another 3 years and you’re payments are higher than what you are currently paying--$407, but your total cost only goes down to $14,645. Add on the $8,640 you paid previously and you’ve spent $23,285.

So what you need to decide is which is more important. Paying less overall or reducing your monthly payment and paying a bit more in total? Does that $3,000 matter to you? Maybe you’d be better off investing that money? But then again, it’s not like you’ve got that cash lying around. If you do you shouldn’t be considering this scenario at all. Remember, the name of the game is to reduce debt.