Will Refinancing a Car Save You Money?

iQuanti: Saving money is a relative term. You can look at it from a short-term perspective. Can I lower my monthly payments? You could also view it with a more long-term outlook. Can I decrease the total amount I pay with a refinanced car loan? Both scenarios could fall into the category of "saving money." The question is whether one of them is the right choice for you.

Refinancing to lower your monthly payments

Increasing cash flow is important. It lowers the financial burden of day-to-day living and frees you up to do more of what you enjoy in life. Lowering your monthly car payment by $50 or $100 can make a big difference in this area. Think of it as another night out with your partner, an extra round of golf, or just being able to fill your gas tank one more time.

Are any of these good reasons to refinance your auto loan? Getting a lower interest rate or lengthening the term of the loan will lower your monthly payments. That certainly fits the criteria for "saving money," but that's a temporary fix. 

Of course, you could invest that extra money into something that will earn you a return, like a CD, bond, money market account, or even a good stock. In that scenario, you're both saving and earning at the same time, but does it cover the cost of those extra interest payments you'll make by stretching out the loan term? If you do the math, you may not be saving anything.

Refinancing to decrease the total amount paid on the loan

Your monthly payment on a car loan doesn't all go to the principal. Loans work on an amortization schedule that applies a larger percentage of your loan payment to interest in the early stages of repayment. For instance, a payment of $500 could be split into $250 towards interest and $250 towards the principal. The interest portion decreases over time as you reduce the principal.

To clarify this further, when you refinance to stretch the loan term, you're paying down your principal even slower. By the end of the loan term, you may have paid less per month, but you end up paying more in interest on the amount that you borrowed. That does not classify as "saving" money. There's a better way to do that.

Refinancing for a shorter term, and obviously lowering your interest rate, are the only true ways to save money in the long run. A shorter term could mean higher monthly payments, but the overall amount you pay on the loan will go down and it will be paid off sooner. From a financial perspective, this is real long-term savings.

The Bottom Line: Saving Money is a Relative Term

Yes, we already said this, but it's an important point. You can look at saving money as a short-term exercise or a long-term plan. Refinancing your auto loan to stretch the loan term and lower monthly payments may save money in the present but costs you more over time. Extending your loan term for a longer period could end up costing more money since you'll pay more in interest. Shortening the loan term and increasing payments create long-term savings.

Be wary of origination fees as well. These are the fees the lender charges for their initial services, similar to most commission-based payments. While these are necessary for the lender, they can stack up if you ever refinance your car multiple times and could cost you a lot of money in the long run.

A third option is to just refinance for a lower interest rate. That will both lower your monthly payment and save you money on the overall payout for the loan. This is the ideal situation and one that may work if your credit score and income have gone up since you took out the original loan. If that's your situation, shop around for a lender that can offer this.   

Source: iQuanti