Refinancing a car loan is a good option if it improves your financial situation, and especially when the refinancing doesn’t have any fees associated with it. Sometimes refinancing a car loan might seem like a good option, but may cause more financial harm than good in terms of total cost, credit rating and budgeting. This could happen if the extra cash flow from the car loan refinancing is mishandled, or the loan adjustment rate and term isn’t financially advantageous. However there are several circumstances in which refinancing a car loan may be a good option.
• Lower payments
Lower car loan payments can arise out of a refinanced car loan if either the interest rate is adjusted or the term of the loan lengthened. If interest rate stays the same, but the term of the car loan is extended from 36 to 60 months, it can lower monthly payments but may simultaneously increase the cost of servicing the loan. However, if the refinanced car loan has a lower interest rate with a longer term the cost may stay the same while lowering monthly bills which could be helpful.
• Build credit
If the refinanced car loan is able to assist in making payments on other debts previously unpaid, this is a positive and can help improve credit score associated with the late or non-payment of debt. However, if the refinance increases discretionary income and that income is used as down payment for additional debt, then the affect on credit score may be negative. Also, with an extended payment schedule it can take longer to reduce debt to credit ratio, however having a debt to credit ratio of less than 40 percent on multiple types of credit can be better than having the same for just one type of credit.
• Save money
Ideally a car loan refinance is a good option when it also saves money. This is accomplished most effectively with an interest rate, compounding terms and servicing costs that lower the cost of the loan and monthly payments. For example, suppose the original car loan was for $8,500 at a fixed rate of 6.4 percent interest compounded monthly with a term of 36 months; this would cost $260.13 per month. If the car loan were extended to 60 months at 5 percent would that be good? It would cost $160.41 per month at a lower rate but the total cost would be $259.92 extra interest.
• Improve budget
Another benefit of refinancing a car loan can be with a budget. If too much of one’s monthly budget goes toward car payments it can have a negative affect on other costs, savings, and retirement planning where the net affect can be a magnified loss of money due to misallocation of funds. In the above example, the refinanced car loan is more expensive but requires almost $100 per month less. Should that extra $99.51 be reallocated to a financial instrument yielding three percent, after five years of monthly payments with an initial deposit of just one dollar, the final amount would be $6,440.89.
Keep in mind, the original amount of $260.13 saved or invested after the 36th month would yield $6429.59 after 24 months. Thus, using these numbers it would be more cost effective to use the 5 year auto loan at five percent with monthly savings of $99.51 than the three year plan with deposits of $260.13. If an extra. .51 cents were added to the $99.51 monthly savings over five years a yield of $6,472 would be earned. The financial outcomes between the three year and five year plan are rather minimal in terms of total savings, however at a larger scale, for example with a $40,000 auto loan, the car refinancing provides larger scale affects on cash flow, savings, credit and financial planning.
Sources:
1. http://bit.ly/5RQYy (Bankrate Auto loan)
2. http://bit.ly/aQNJul (Bankrate Savings)