Refinancing a car loan is a really smart thing to do when you notice a significant drop in car loan interest rate. There are many other good reasons too why you should refinance your car loan. For instance, you could refinance if you think you’ll get more benefits by switching to fixed interest rate interest from floating interest rate. However, before you make any decision it is important that you make yourself well-informed and understand all the aspects of refinancing a car loan.
What Does it Mean to Refinance a Loan?
When you refinance a loan you basically pay off your current debt with another loan that you will repay. This new loans comes with a different payment structure and its own set of terms and conditions. You could also have to pay a certain fee or fine when you refinance a loan.
Factors to Consider When You Refinance a Loan
Refinancing your car loan could save you a lot of money. However, there are some factors that you must consider when you refinance.
One of the most common reasons why people refinance a car loan is better interest rates. For example, say RBI recently released a new policy that makes it mandatory for the banks to cut their interest rates for auto loans. However, you see that your bank is not willing to give that benefit to existing borrowers. In such situation you could go for refinancing. You could either apply for refinancing with another bank that is offering a better interest rate, or you could switch to floating interest rate from fixed interest rate with your current bank so that you can enjoy the lower interest rates issued by RBI.
When you take your loan to another bank through refinancing then you are charged a processing fee which could be anywhere between 0.5 % to 1% of the pending loan amount. Thus, the money you will save by refinancing has to be sufficiently higher than the amount you will pay in processing fees. Otherwise there is no point of the whole thing given that the only reason you are refinancing is to save money.
Floating Interest Rate Vs Fixed Interest Rate
More often than not the nature of the interest rate has a greater significance than the amount of interest rate when it comes to loan refinancing. The tenure of your loan could be as long as a decade and thus, every small thing matters. It is difficult to predict how the market will be like in future, or how will the interest rates change. You could stick to fixed interest rate and take comfort in the fact that you won’t have to pay higher than what you are paying now, although you won’t be able to take advantage too if the interest rates come down. On the other hand, you can take your chances and opt for a floating interest rate.
To understand how refinancing can be beneficial for you consider the example of Arun. He has a HDFC bank car loan of 10 lakhs outstanding for next 10 years. Since the rate of interest was 10.5% he is paying an EMI of Rs. 13,493. However, despite the fact that loan interest rates have dropped his bank is not letting him avail a lower interest rate. So, he decides to talk to another bank which agrees to refinance his loan at an interest rate of 9.5%. Let’s see how much money Arun will be able to save by refinancing:
|Loan Details||Case 1||Case 2|
|Total Interest Paid||6,19,220||5,52,771|
So, you can see that by refinancing he is able to save about Rs. 67,000 (6,19,220-5,52,771) on the interest, which only goes to show that refinancing can be a really smart thing to do when the timing is right. If you think you too can save money on interest then you can apply for refinancing either at your own bank or to some other bank where you are getting a better deal.