How Fees and Early Payoff Penalties Affect an Auto Refinance Deal

There are many excellent reasons for people being in the market for an auto refinance deal. Some may be paying too much because their credit scores have risen since they were approved for their current loans. Some may be facing financial issues and urgently need to reduce their monthly outgoings -- or risk losing their vehicles. Some may have loans that date back to periods when rates were higher. And some may simply have signed up to deals that were too expensive because their eyes were on the shiny cars and not on the boring loan forms. Whatever the driver behind a refinancing your car loan, one factor can push some off course: early payoff penalties. They can, but they only sometimes do. Luckily, it's easy for anyone to discover whether or not he or she is affected.

Early Payoff Penalties

Early payoff penalties (often known as prepayment penalties) are fees or compensation for lost interest that a lender may be able to charge when a borrower zeroes the balance on an account before the end date agreed in the loan contract. If provision for such a penalty is contained in the agreement, it's going to be incurred during refinancing: payment in full of the original loan is a necessary part of the refinancing process.

The laws governing such charges vary from state to state. However, all lenders are obliged to indicate in the loan agreement -- and on a Truth in Lending disclosure form that must be shown under federal law to the borrower when or before the agreement is signed -- whether those penalties apply. There's a good chance they won't. And some auto loan companies charge only quite small amounts that reasonably compensate them. But the only way to be sure whether there's an obligation and how much it might be is to check the original loan documentation.

Anyone who can't find the paperwork can call his or her lender to request the payoff amount required to end the loan. It will soon be obvious whether a prepayment penalty is being charged, and how reasonable or otherwise it is.

The payoff amount usually becomes the sum that needs to be refinanced. (The sort of "cash-out" refinances seen with mortgages are rare with auto loans, because vehicles tend to devalue too quickly.) And once that's known, borrowers can use auto loan calculators to model their options and explore affordability according to their own individual personal circumstances. It's now that the potential savings from a refinancing can be estimated.

Precomputed Interest

Car dealers (but not banks or credit unions) sometimes have loan agreements that include the term "precomputed interest." These are bad news.

One of these loans gives the dealer the right to every cent of the interest theoretically due under the agreement regardless of when it is paid down. And, unfortunately, that is virtually certain to make any auto refinance deal on one of these uneconomic.

Loan Fees

For anyone who's been through a mortgage refinancing, loan fees for an auto one are a pleasant surprise. Many lenders charge nothing at all, and those that do usually want nominal amounts.

Some states charge for registering changes to liens or titles, but again the sums involved are generally fairly small. By contrast, the amounts that can be saved by shopping around for the best auto loan rates can be considerable.

Just one more thing: Before signing any future loan agreements, be sure to check on prepayment penalties -- and especially on those dreaded precomputed interest provisions.

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