How to Calculate Savings From Auto Loan Refinancing
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Reviewed by Calculator Editorial Team
Refinancing your auto loan can save you money over time by lowering your interest rate and reducing your monthly payments. This guide explains how to calculate your potential savings and what factors to consider before making the decision.
Why Refinance an Auto Loan?
Refinancing your auto loan is a common strategy to save money on your vehicle's financing. Here are the primary reasons people refinance:
- Lower interest rates: When interest rates drop, refinancing can reduce your monthly payments.
- Better loan terms: You may qualify for a longer loan term that reduces your monthly payment.
- Improved credit score: A higher credit score can lead to better refinancing terms.
- Switch to a different lender: Some lenders offer better rates or special refinancing programs.
However, refinancing isn't always the best option. There are fees associated with refinancing, and you may not save enough to justify the process.
How to Calculate Potential Savings
To determine if refinancing will save you money, you need to compare the costs of your current loan with the potential new loan. Here's how to calculate your potential savings:
Formula for Calculating Savings
Potential Savings = (Current Monthly Payment - New Monthly Payment) × Loan Term
Where:
- Current Monthly Payment = Current Loan Amount × Current Monthly Rate / (1 - (1 + Current Monthly Rate)^(-Loan Term))
- New Monthly Payment = New Loan Amount × New Monthly Rate / (1 - (1 + New Monthly Rate)^(-Loan Term))
- Loan Term = Number of months in the loan
This formula calculates the total difference between your current and new monthly payments over the life of the loan. If the result is positive, refinancing could save you money.
Note: Always factor in closing costs when considering refinancing. These fees typically range from 2% to 5% of the loan amount and can offset potential savings.
Worked Example
Let's look at an example to see how this calculation works in practice.
Current Loan Details
- Loan Amount: $20,000
- Interest Rate: 8% APR
- Loan Term: 60 months
Potential New Loan Details
- Loan Amount: $20,000
- Interest Rate: 5% APR
- Loan Term: 60 months
Calculation
First, calculate the current monthly payment:
Current Monthly Rate = 8% / 12 = 0.6667%
Current Monthly Payment = $20,000 × 0.006667 / (1 - (1 + 0.006667)^(-60)) ≈ $376.54
Next, calculate the new monthly payment:
New Monthly Rate = 5% / 12 = 0.4167%
New Monthly Payment = $20,000 × 0.004167 / (1 - (1 + 0.004167)^(-60)) ≈ $338.56
Now, calculate the potential savings:
Potential Savings = ($376.54 - $338.56) × 60 ≈ $2,251.20
Result: In this example, refinancing could save you approximately $2,251 over the life of the loan. However, you should also consider closing costs before making a final decision.
Key Factors to Consider
Before refinancing your auto loan, consider these important factors:
1. Closing Costs
Refinancing typically involves closing costs ranging from 2% to 5% of the loan amount. These fees can offset potential savings.
2. Loan Term
Refinancing to a longer term can reduce your monthly payment but may increase the total interest paid over the life of the loan.
3. Credit Score
A higher credit score can qualify you for better interest rates and lower monthly payments.
4. Market Conditions
Interest rates fluctuate, so timing your refinancing decision is crucial.
5. Loan Type
Consider whether you want to refinance to a conventional loan, government-backed loan, or another type of financing.
FAQ
How long does it take to refinance an auto loan?
The refinancing process typically takes 30 to 45 days, but it can vary depending on your lender and the complexity of your situation.
Can I refinance an auto loan with bad credit?
Yes, but you may face higher interest rates and fees. Specialized lenders cater to borrowers with less-than-perfect credit.
Is it better to refinance or extend my auto loan?
Refinancing is generally better if you can secure a lower interest rate. Extending your loan term may increase your total interest payments.
What happens to my existing loan if I refinance?
Your existing loan will be paid off with the proceeds from your new loan, and you'll receive a check for any difference in amounts.