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Is it a good idea to refinance a car loan?

June 20, 2011: 5:40 AM ET

What are the pros and cons of refinancing a car loan? — Name withheld


Refinancing a car loan can offer tremendous savings, especially given today's low-interest rates. For the savings to be worth the hassle, however, the rate difference should be at least five percentage points, says John Ulzheimer, a credit expert and founder of SmartCredit.com."It's really only a logical choice for someone who has a horrific interest rate, like in the teens," Ultzheimer says.

In order to land an attractive rate for your refi, you'll need good credit. If you've improved your credit score since you first took out your loan or if you're bringing in a steadier paycheck it will greatly improve your odds of landing a more favorable rate, says Manisha Thakor, a personal finance expert and founder of the Women's Financial Literacy Initiative.

To save even further, opt for a shorter-term loan, say a three-year instead of a six-year (assuming you can afford the monthly payments). By doing so, you'll also reduce the amount of interest you'll pay over the life of the loan, says Thakor.

The con: if you're more than a couple of years into a five-year loan, stretching out the payments for another three to five years may save you money each month, but the extra interest you pay over the years would negate any of the benefits you gain from refinancing in the first place.

When shopping for loans be sure to check local credit unions, which offer some of the best deals, says Ulzheimer. And steer clear of financing companies, which are considered lenders of last resort because of their willingness to lend to subprime customers. Because of this elevated level of risk, loans from these companies can weigh on a credit score.

"If you can refinance your loan with a bank or credit union, you are going to boost your credit, " says Ulzheimer. "Plus, the terms you get from a bank or credit union are infinitely better."

— Nicole Ridgway

Posted in: Credit, Family Money
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