New car buyers often finance their purchase through a new car loan. In many cases, new car buyers let car dealers set up the finance terms. This often leads to higher interest rates, since the dealership also derives some of its income from the auto financing business.
When you refinance you replace your old debt obligation with a new debt obligation under improved terms. Car or truck loan refinancing can help you save money by:
- Reducing monthly payments
- Shortening the loan term
Let’s take a look at these two situations in detail.
Lower Your Monthly Payments
Any car loan is made up of the principal and interest. The principal is basically the cash value of the vehicle, and the interest is what you pay in order to borrow money. When you refinance your auto loan, the main advantage is a lower interest rate. You can use this not only to lower your monthly payments but your overall payment as well.
Let’s say your original loan amount is $35,000 with a 60 month payment term. If your original interest rate at purchase was 10%, then your monthly payments are $743.65 and you will pay $44,619 over the life of the loan of which $9,619 is interest.
If you refinance the loan at an interest rate of 4.75%, with the same 60 month term, your monthly payments would be reduced to $656.49. So you save $87.16 per month. The total that you would pay is reduced to $39,389.40, and what you pay in interest is reduced to $4,389. Your total savings is $5,229.60.
The following table summarizes your savings in this scenario:
Loan Amount = $35,000
|Original Loan||Refinanced Loan|
|Term||60 months||60 months|
|Monthly Savings = $87.16||TOTAL SAVINGS = $5,229.60|
Shorten Your Loan Term
Another way you can save is by shortening your loan term. When you choose this option, your monthly payment stays about the same, but you finish paying down the loan earlier. This can be achieved thanks to the lower interest rate acquired through refinancing.
For example, if your original loan is $40,000 at 9% interest, then your monthly payment is $721.02. Over the life of the loan you would pay $51,913.44. If you refinance with a new loan at 6% interest rate you may choose to make roughly the same monthly payment at $713.05. The difference is that now you only have to pay for 66 months instead of the original 72 month term.
In this example, your total interest payment is reduced from $11,913.44 to $7,061.30 for a total savings of $4,852.14.
The following table summarizes this type of refinance strategy:
Loan Amount = $40,000
|Original Loan||Refinanced Loan|
|Term||72 months||66 months|
|TOTAL SAVINGS = $4,852.14|
There are two ways in which you can save when you refinance your auto loan. One is by reducing your monthly payments and the other is by reducing the term of your loan. In both cases, your total finance charges are reduced over the life of the loan. The key in both of these cases is the lower interest rate obtained through refinancing. Look into refinancing to see if you can save, especially if you originally financed through a car dealer.
About The Author
Joe Campanella is the EVP of Business Development for CARCHEX and oversees partner relationships. Joe possesses 12+ years of experience building sales/customer service teams and securing strategic partnerships. He is a sports enthusiast who enjoys mountain biking, surfing and snowboarding in his spare time.