How To Determine If Refinancing your Automobile Loan Is A Good Idea
Saving money and being able to keep more money in my pocket each month sounds great, sign up me, right?
Not so fast, there’s a couple of things that need to be checked before I speak to my banker.
Know Your Interest Rate
We purchased our van two years ago using a 5 year loan at a 1.99% interest rate. The rate offered by my bank on a vehicle refinance loan is 3.61%, nearly double my current interest rate!
Check The Amortization Schedule
The paperwork given to me at the time we purchased our vehicle came with an amortization schedule showing how much of every payment is applied to the principal, and how much is paid in interest. Using the information from the paperwork, I can determine how much interest I have left to pay. Next, I can use a loan calculator to plug in the new loan information and get an amortization schedule for my potential auto refinance. If the interest paid for the new loan exceeds the interest remaining to be paid on my existing loan, refinancing will not save me money!
Do The Math
Let’s look at an example:
Let’s say I financed $30,000 at 1.99% for 60 months. Two years into my loan, here is the pertinent information:
- Balance: $17,861.39
- Monthly Payment: $525.70
- Interest Paid: $1,003.93
- Interest Yet To Pay: $508.54
Now, let’s look at what would happen if I refinanced my van today with the offered rate of 3.61% for a brand new 60 month term.
- Balance: $17,861.39
- Monthly Payment: $325.80
- Interest Paid: $0
- Interest yet To Pay: $1,687.20
Many people will look at this information and see that the payment is reduced by $200 a month and think that refinancing the vehicle is a great idea. That’s what your bank wants you to think.
The reality is refinancing would actually COST MORE money.
First, the clock on the term of my loan is restarted. With my original loan I had three years remaining. Should I refinance the vehicle, I get a brand new five year loan meaning I’ll be making payments on my vehicle for a total of seven years (2 years already paid PLUS the new 5 year term).
Because the term is restarted, the amount of interest I will pay increases. During the first 2 years of the original loan, I paid $1003.93 in interest. I will now pay $1687.20 during the new 5 year loan, meaning I will pay a total of $2691.13 in interest. Had I simply finished out my original loan, I would have paid a total of $1512.47.
Refinancing would cost an extra $1178.66!!
Sometimes life circumstances require a refinance of this type to create breathing room in the monthly budget if money is tight. That is not the case for me, therefore I will NOT be refinancing my auto loan.
Interest rates, terms, and other conditions will vary to your personal situation. The moral of the story here is before refinancing your vehicle, don’t get hypnotized by a lower monthly payment. Evaluate the numbers, do the math, and make an educated decision that’s best for you.
Have you ever refinanced an automobile loan? Did you do the math to determine if it actually saved you money first?
Brought to you courtesy of Brock
Brock is a software engineer by day and personal finance blogger at night. He is a fitness junkie and enjoys grilling and smoking meat. Married with two children, Brock strives to improve his skills as a husband and father, and is always on the lookout to stretch his family’s budget as far as he can.
Do people actually fall for these kinds of offers? I’m all for refinancing, but that’s only if you first got a high interest rate like 9% and you have the chance to reduce it to a lower percentage rate! I guess I can see why some people would fall for a lower payment if they’re struggling to make ends meet, but it’s definitely not a wise financial decision.
It’s cool to see those numbers ran though!
It does seem odd that people would fall for this; unfortunately plenty do.
Thanks for the clear and concrete example! I don’t honestly know a lot about refinancing, but this was a great first lesson.
I refinanced once. I got divorced and he “generously” allowed me to keep the car… And the payments. So I refinanced, partially out of spite because I didn’t want my faithful bill paying to improve his credit score (though I know it still got paid just early, which isn’t always better for installment loans.) But the other part was that on a solo income I literally couldn’t afford the old payment. I did get a better interest rate (refinanced at fed lows and initially bought before the recession,) and my loan was not that large. But I still spent more by drawing it out. Didn’t have much of a choice, though. Paid it off early and saved a whopping $70 in interest.
So I’m agreed. Haha. Refinancing is rarely a good option.
@Liz – yeah, unfortunately people do. They look at the lower monthly payment and just assume it’s a good deal for them!
@RAnn – for many, it’s all about the monthly payment. If it’s lower, it’s good for them (they think). Now, there are certainly extreme situation where a person HAS to take an overall hit to free up room in their monthly budget….but they should do so only with their eyes wide open, knowing exactly what they’re getting into.
@Mel – Hopefully if you ever consider refinancing anything (car, home, etc), you’ll take my advice and make sure you run the numbers. Thanks for reading, Mel!
@FemmeFrugality – sounds like you ran into one of those situations where you needed to take a hit in the long run in favor of a lower monthly payments. The good news is that at least you knew what you doing, and made an educated decision. Thanks for sharing!