A few years ago I bought a new car (well, it’s a used car, but it was new to me). The initial financing terms were not super-great, but the loan was easy to get as part of the purchase. Because I was confident in my ability to refinance after the fact, I took out that initial loan.
That original loan had 60 monthly payments of $236.
I then proceeded to shop around for a better car loan, and found one with a much better interest rate.
The loan I could refinance into had 60 monthly payments of $206.
Assuming I wanted to make 15% on my money, and assuming that I was able to refinance within the first month of the original loan (making the time period covered by the two loans the same), what’s the most I could pay to do the refinance?
This one is fairly straightforward, but some readers may be thrown by the fact that I told you nearly nothing about the two loans in question. The good news is that to find the answer, you don’t have to know how much I borrowed (on either loan – the amounts might not be the same) or the interest rates on either loan. Why? The question is about the differences between the two loans, not about the loans themselves.
Since the second loan is $206 per month, and the original loan was $236 per month, if I do the refinance, I’m saving $236 – $206 = $30 per month over the life of the loan.
First things first, make sure the calculator is using 12 Payments per Year.
N: 60 (I’m saving money each month for 60 months)
I/YR: 15 (I want to make 15% on my refinancing costs)
PV: (This is what I’m trying to find)
PMT: 30 (I’m saving $30 per month over the life of the loan)
FV: 0 (When the loan is paid off, the savings ends… but at that point I won’t have a car payment anymore, so I’ll be even better off)
The answer to the question is the most I could pay to do the refinance would be $1,261.04.
I actually paid more for the refinance than the target amount ($1,261.04), but I was able to roll the costs into the refinanced balance, so I didn’t have to pay anything out-of-pocket. I was able to do this by dropping the interest rate enough that the savings still came out to $30 per month.
The only risk there was that my new balance might be more than the car was worth, but part of the refinance cost was the purchase of a ‘Gap Insurance’ policy, which covers the difference in case my car is totaled and my auto insurance pays out less than I owe on the loan.
What do you think? Would you do this kind of refinance? Could you do one right now?
Let us know in the comments!