Money Saving Mondays: How to know if your loan should be refinanced
I went into the bank the other day to see if I should refinance our car loan. I have really outstanding credit and I wondered if I could parley that into a lower interest rate, shorter term or lower payment. Turns out that I could do all three, but I did not do it after I saw the numbers.
Original loan principle: $17,490
Interest rate: 8.01% Total term: 72 months
Monthly payment: $306 Total P and I: $22,085
Total interest paid over the life of the loan: $4,595
Remaining principle: $11,850
Interest rate: 8.01% Remaining term: 45 months
Monthly payment: $306 Total remaining: P and I: $13,758
Total interest remaining: $1,908
When I walked into the bank, I assumed that I was about to refinance my loan. About fifteen minutes later, I walked out without a new loan even though I was offered an interest rate that was two points below my current APR. Here were my options:
If I paid an additional $75 per month:
Monthly payments would be $381
I would pay off the loan 11 months early
Total repayment: $21,655
I would save a total of $430
If I were to lower my monthly payment:
6.01% for 48 months
Monthly payment: $278
I would take 3 months longer to finish the loan
Total repayment: $21,623
I would save a total of $462
If I were to shorten the term and lower the rate:
6.01% for 36 months
Monthly payments would be $361
I would pay off the loan 8 months early
Total loan repayment would be $21,242
I would save a total of $413
As you can see, I could actually save a little money by lowering my interest rate and extending the length of the loan in Option #2. However, if I can pay extra principal every month as in Option #1, I can significantly reduce the term of the loan. Option #3 offers a lower interest rate, a shorter term, a higher monthly payment, but, surprisingly enough, I would pay more interest than option #1. Option #2 lowers my monthly payment $28, but lengthens the loan by three months. The loan also came with a refinance fee – I cannot remember the amount – but it would have added to my principle up front or I would have had to pay out of pocket.
The question that made the difference was, Are you trying to lower your payments or accelerate your loan payoff?
I was too focused on the interest rate. I assumed that at lower interest rate would automatically make it easier to pay off our car loan. But I learned that a refinance makes sense only if your principal amount is really large – like with a home mortgage or large amounts of school loans. However, if you are having no trouble making your payments and your principle is lower than $15,000, paying down principle will usually make more of a difference than going through the trouble of a refinance, even if the APR reduction is a lot.
In my case, I just want to get rid of this debt as soon as possible. I am going to add every spare dime that I can to my car loan payment and accelerate out of debt.
Article by Stew
Photo by Martin Pettit