Are you paying more than you need to on your car loan? Nobody wants to overspend when they don’t have to, and refinancing your auto loan can result in savings, both monthly and over the course of your loan.
However, you will need to carefully examine your current situation and run some numbers to find out whether you can indeed get a better deal. Here’s a step-by-step breakdown to evaluate whether refinancing your auto loan makes sense.
Refinancing by the numbers
When you refinance your auto loan, you get a new loan that replaces your existing loan. You use the new loan to pay off your old loan and then make payments to your new lender. The goal is to get a lower interest rate, which will effectively lower the amount you pay for your car monthly and overall. Is it the right financial move for you? Here’s how to find out.
Find out how much you still owe toward the principal on your existing loan. This is also sometimes referred to as the “payoff amount.”
Find out how much interest you will pay over the time remaining on your existing loan. This can be found by contacting your lender or looking at the amortization schedule of your current loan. An amortization schedule shows how your payments are broken up between interest and principal and it can be presented monthly or yearly.
Add together the remaining amount owed on the principal of your existing loan and the estimated interest you will pay over the remainder of the loan.
This is the number you will want to beat with the new loan.
Shop around to find out what other lenders can offer you and look for the one who can offer you the lowest interest rate. If the rates you are offered are not lower than your current interest rate, you probably shouldn’t refinance. However, if your goal is to lower your monthly payment because you are struggling, refinancing at a similar interest rate and extending your loan term would achieve that goal. Of course, this isn’t recommended unless it’s an absolute necessity because you will pay more for your car in total.
If you’re not in danger of defaulting, and lower interest rates aren’t available, it may be best to keep working on your credit. When lower rates are available, it’s great news and you can continue to step 5.
Calculate the monthly payment and total cost for various available loan lengths (36-month, 48-month, 60-month, etc.). Below are the options you will have when deciding on the length of your loan term and what you should consider about each.
Shorten your loan term
This means you will choose a loan term that is shorter than what remained on your last loan. For example, you may go with a 36-month term when you had 48 months remaining on your last loan. The benefit of this route is that you will pay less for your car overall because the shorter term reduces the amount of interest you pay. The disadvantage is that your monthly payment will be higher than the other options.
Keep the loan term the same
With this choice, you will choose the loan term closest to what remained on your last loan. This probably will result in a small decrease in your monthly payment, allowing you to save monthly and over the course of your loan.
Extend the loan term
With this option, you will choose a loan term that is longer than what remained on your previous loan. For example, if you had 48 months remaining, you would choose the 60-month loan. The advantage here is you will get the lowest monthly payment of the three options. The disadvantage is that the total cost you pay over the course of the loan will be higher than the other choices. However, if you got a significant reduction in your interest rate and can still save overall and monthly compared to your previous loan, this can be beneficial.
Once you run the numbers and understand the outcome with each loan length, you will have all the information you need to make an informed decision on whether auto refinancing will benefit you. You may find that it won’t save you enough at this point to warrant the refinance, or you may find that it does. If it does, your decision will be based on where you see the most value; whether it is a reduction in monthly payments, a reduction in the overall cost of your car or a balance of the two.
Now let’s take a look at the above steps in action. (Estimates in this example are per the annual amortization schedule calculated using Calculator.net and the Bank of America auto loan calculator)
Julie has a 60-month loan of $15,000 with a 5.2% annual percentage rate (APR), the national average for new car loans in the first quarter of 2016, according to the Federal Reserve. Her monthly payment is $285. She took the financing deal offered to her by the dealer she bought the car from but has since seen much lower rates advertised. Additionally, she has improved her credit and is now considered to have an “excellent” rating. This qualifies her to get one of the ultra-low advertised rates from lenders such as USAA and Lightstream.
One year has passed since her original loan was initiated and she now owes about $12,300 on the principal and $1,350 in interest. That puts her number to beat at $13,650.
A new 48-month loan for the $12,300 with a 2.19% APR would drop her payment to about $267 per month and would put the total cost of the loan at approximately $12,857. That would save her about $18 per month and $216 per year. By the end of the four-year loan, she would save about $795. Note that the new loan length in this example is equal to the number of months remaining on the original loan.
She could also extend the length of the new loan to drop the monthly payments more significantly. If the new loan was for 60 months, adding one year, she could lower the monthly payment to around $215 per month. This would be a savings of about $70 per month. In this case, she would pay about $13,375 over the course of the loan, still putting her $275 under the number to beat.
If she shortened the loan length by one year to 36 months, her monthly payment would be about $350 and the total interest would cost about $420. This puts her total cost at $12,719, a $930 savings over the duration of the loan.
So to sum up the figures for her $12,300 loan:
- Original loan at 5.2% APR: $285 per month, $13,650 total cost
- 36-month loan at 2.19% APR: $350 per month, $12,719 total cost
- 48-month loan at 2.19% APR: $267 per month, $12,857 total cost
- 60-month loan at 2.19% APR: $215 per month, $13, 375 total cost
With this information, she can easily weigh her options to decide whether she wants to save more monthly, save more on the total cost or a little bit of both. It would also be apparent if one of the options was not able to beat the original loan, making it easy to rule it out. By making a similar summary with the figures for your situation plugged in, you can make an informed decision.
Shop auto loan refinancing companies
If you decide that refinancing your auto loan is an option you want to investigate further, it’s important to shop around to see what kind of rates you can get. For a wide range of lenders, summaries of their offerings and real user reviews, head over to our Auto Loan Review page.
Once you find the right lender, keep these steps in mind to ensure you save money and get the advantages you want most when refinancing your auto loan.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.