3 roadblocks to refinancing your auto loan

Percent sign on windshield

It makes a lot of sense for many consumers to refinance their homes at today's rock-bottom interest rates. So what about your car or truck?

An auto loan is the largest, or second-largest, debt many of us are trying to pay off.

Is it possible to substantially lower your monthly payments and reduce the total amount of interest you ultimately pay by refinancing your auto loan?

Yes. But it's very hard to do.

Most owners trying to refinance a car or truck stumble over three serious roadblocks that make it difficult, if not downright impossible, to refinance an auto loan.

Roadblock 1. You can't borrow enough to pay off your current loan.

If you bought a new car or truck less than three years ago, there's a very good chance you owe more on your loan than your car or truck is now worth.

Nor will most banks and credit unions loan you the full, current market value of the vehicle in a refinancing.

That means you'll probably have to come up with thousands of dollars to cover the difference between what you owe on your current note and what you can borrow with a new loan.

Let's say, for example, that the balance on your current loan is $20,000, the resale value of your 2-year-old car is $17,000 and the bank is willing to provide 90% of its current value in a refinancing.

That means you'll get a new loan for $15,300 and must come up with the difference, or $4,700 in cash, to pay off the first note and clear the title.

Roadblock 2. Your car or truck is too old.

We've seen banks and credit unions advertising very attractive refinancing rates that are only a half point higher than they're charging for new car loans, somewhere between 4% and 5%.

But those deals are usually restricted to vehicles no more than one or two years old. If your car or truck has been on the road longer than that, a new loan will almost certainly come with a higher rate that's closer to what the bank or credit union charges to finance used cars.

As the rate goes up, the advantage to refinancing goes down.

Roadblock 3. Your credit score is not good enough.

Borrowers with the most expensive car loans -- and with the most to gain from refinancing -- are usually paying high rates because they have bad credit.

Experian, one of the major credit reporting agencies, says buyers with really good credit paid an average of 4% for a new-car loan during the second quarter of 2010, while someone with really bad credit paid an average of 13.1%.

That works out to a monthly payment of $368 a month on a 60-month loan for $20,000 for the buyer with good credit and $456 for a buyer with bad credit -- an $88 difference.

But you probably won't be able to qualify for a substantially lower rate through a refinancing if your credit score isn't substantially better than it was when you took out your current loan.

Our auto loan calculator will allow you to compare the monthly payments for three different possible terms and see how much you can save.

If you are able to swing a deal where it appears refinancing could save you money every month: 

One final thought. Trading in your car or truck for a new vehicle is often the best solution to an expensive auto loan.

New-car financing always offers the lowest interest rates, and you now have the chance to buy a less expensive ride.

The combination of a lower rate and less debt can add up to a substantially lower monthly payment. And isn't that what you're really after from a refinancing?