You have an asset you purchased with a loan and would like to change the terms of your loan with your current lender or change to a new lender because they have a better deal, which typically means a better interest rate, refinance. You move the principal (amount you owe before interest) to another lender. Loans consist of principal and interest. Interest is the money you pay the lender for borrowing their money to purchase whatever you needed/wanted.
My job is offering a great auto loan rate right now. It’s 3.5%. Of course, this is for people with good credit (very important to maintain a great credit score). I get .5% less than the public because I am an employee, so I can get 2.99%. My first thought was that is 2.5% less than the interest rate I have now. Time to refinance! But wait…let me go to an online financial calculator and calculate my savings over the life of the loan.
First, you have to define why you are refinancing. Are you refinancing to lower your payment because you can’t afford the payment, really need the cash in your pocket, or to increase the amount you pay to principal, thus, paying less interest? Mine was to pay less interest, which means I am paying more principal. My thinking—-> I’ll pay my current monthly payment on a new loan with a low monthly payment and interest; I’ll save on interest without feeling a change monthly. But after my calculations using my handy dandy financial calculator, I have some thinking to do. This is more than a face value monthly payment. This has to do with time as well. These are my thoughts…
How much time do I have left on my loan and the remaining principal? My car will be paid off in 28 periods and there is not much left to pay off. Since car loans are typically 36 or 60 periods, their terms push me out 8 more months (28+8=36 months), unless I pay it off. If I am going to pay my car off, I might as well ante up on the loan I already have, but I am not going to do that. I have an anxiety attack whenever I spend large amounts of money in one sitting. Remember when you paid for your courses and that trip. Saving is a great effort that takes time. Spending only takes seconds.
If I wanted to lower my payment, this deal sounds great. I would have $200 more per month in my pocket by refinancing, but I have extended my loan periods prolonging the expense. But hey! I am not going to knock it. Depending on your situation and circumstances (about to default or barely making it), you might need that $200 for necessities. If you can save the $200 per month and just pay to principal at the end of the year after starting and maintaining a rainy day fund, do so. If you will not use the money to pay down the principal, I would advise you don’t refinance.
I don’t need the extra money and my goal is to get rid of this car payment. So now, I am back at square one, keep the current loan and pay more on it to get rid of it. When I ran the numbers, I only saved $300 over the life of the loan by refinancing for 36 periods and paying the additional $200 on principal every month with the new loan. So in the end, I’m not going to refinance.
Be careful. What looks good may not be all that good.
The best calculators of all time and they include amortization tables