Money Saving Mondays: How to know if your loan should be refinanced
By Stew
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: $4,595Remaining 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 $430If 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 $462If 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
February 15th, 2010 at 3:46 pm
If it doesn’t cost you money to refinance into a lower interest rate by all means you should do it. Simply refinance and continue you to pay the loan as you planned. You won’t save alot of money due to your balance, but a little is better than nothing.
February 15th, 2010 at 9:18 pm
Very true.. paying a little more every month saves both money that would have gone to interest and time it will take to payoff the loan. We stretched ourselves and paid off our car note in eleven months saving $2100 and 18 months of payment
February 17th, 2010 at 1:06 pm
Unless the refinance fee is more than $400, you are probably better off refinancing to the 6.01% loan. Here are the numbers I got from the auto loan calculator at Bankrate.com.
Pay original loan as agreed to term: total interest $1908
Pay $381/month on original loan: total interest $1478
6.01% loan for 48 months @ $278: total interest $1511
6.01% loan for 36 months @ $361: total interest $1130
6.01% loan for 34 months @ $381: total interest $1065
Please check my numbers to see if I made a mistake anywhere. If you’re planning on paying $381/month, you may as well go for the lower interest rate. If you want flexibility, it may be best to keep your lower payment.
Good luck!
February 17th, 2010 at 1:44 pm
That’s the approach we’re taking with our mortgage. We got a 15 year loan at 4.625%, so the terms are good… but we don’t want to still be making mortgage payments 14 years from now. We’d rather put all of our extra money towards our house now, and be free of debt as quickly as possible. We have the amortization table that the bank gave us at closing hanging on our fridge. It’s a great feeling to look at where we are versus where we would be if we hadn’t been paying extra… and we’re only 8 months into the mortgage. It just gets better as time goes by. Good luck with paying off the car early!
February 17th, 2010 at 2:30 pm
First Step, you are correct and I meant to include in the article that I would like to keep the payment flexibility just in case our situation changes.
February 23rd, 2010 at 6:32 am
It is nice to see that people look at the outcomes rather than just jump on a refinance.
Up in Canada we are a little different in relation to our mortgages. If the mortgage gets refinanced early at a lower rate a penalty is paid that wipes out any savings to be had.
Most people don’t look at the end result. The take the lower rate, the lower monthly payment and beleive they have come out ahead when in reality there is no benefit or you are losing money.