There’s nothing more depressing than paying high monthly amounts on your auto loan for years on end. Use these tips to pay off your car loan faster, improve your credit, and save money in the long run!
Here are a couple of quick numbers for you- the average length of car ownership in the US is 8.4 years for new vehicles and about 4 to 6 years for used vehicles. However, did you know that almost 69 of those months (or 5.7 years) are spent paying car loan payments? That essentially means that Americans actually “own” the car they drive for less than a year before replacing it!
While taking on a long loan term may seem great because of the low monthly payments, you will often end up paying more than the principal in the long run! If you would rather pay off your car loan in the fastest way possible, then you’re in the right place.
Should you pay off your car loan faster?
To decide whether you want to pay off your car loan soon, analyze the following factors and see if you can save more money in the long run.
- Remaining loan term: Generally, any loan term longer than 72 months will incur high-interest charges. If you had taken a 72-month, 84-month, or 96-month loan, it makes sense to pay it off soon.
- Current remaining balance: Still have a large loan balance after 3-4 years of monthly payments? You’ll save more money by closing it as soon as possible.
- Prepayment penalties: Lenders receive interest for every month of the loan term, so they typically do not encourage early payoffs. If the prepayment penalty is negligible compared to the savings you’ll make, then it’s better to pay off the loan.
- Calculate how much you can save: Use an auto loan calculator to find out your gross savings quickly. Even if it isn’t as much as you expected, closing the loan may have other knock-on effects like a bump in credit score, etc.
- Current credit score situation: Paying off a loan early can help your credit score by lowering the amount of credit you use. The less debt you have, the more likely it is that your credit score will go up. Lenders prefer borrowers with a low credit utilization ratio, showing that you can make payments on time and not use up all of your credit. However, it could negatively affect your credit score if you have no other open installment loan options.
How to pay off your car loan early
Refinance your auto loan for a lower term
Auto refinancing is a great way to reduce your loan term and pay off the loan easily. Refinancing your car loan involves taking on a new loan with better terms and conditions than your current loan. The new lender will pay off the existing loan balance, and you get to pay reduced payments due to a lower APR, shorter loan term, or both. Keep in mind that this only works if the new loan term is smaller than the current one.
Review any add-on expenses in your car loan
Paying off your current loan will take longer than usual if you have additional expenses and plans bundled into the loan amount. Some examples of these add-ons include:
- Extended Warranties
- Vehicle Service Contracts
- Guaranteed Asset Protection (GAP)
- Tire, wheel, and maintenance warranties
Depending on which ones are important, you can exclude unnecessary items and reduce the total loan amount to be paid. Different dealers may have their own procedures for excluding these add-ons, so reach out to them if you want to economize.
Choose bi-weekly payments
Bi-weekly payments allow you to make one extra payment every year. If you choose monthly payments, you will make only 12 full payments in a year. However, choosing the bi-weekly option means that you’ll pay 26 half-payments or 13 full payments. This can help you make one additional payment in a year and close the loan earlier.
Ensure extra payments go towards paying off the principal
Unless explicitly mentioned, most of the extra payments you make go towards repaying the interest charges and not the principal. However, making more payments to your principal can quickly reduce the amount of time you spend paying off the loan.
This is because auto loans use simple interest to calculate monthly payments. Repaying the principal first helps reduce the loan balance faster, thereby bringing down the time spent repaying the loan. Ensure the extra payments are marked “principal-only” when paying.
Use methods to prioritize
The Snowball Method of debt payments involves making extra payments to the smallest debt you owe until it is completely paid off. If you have multiple loans, you can start with repaying the smallest and work your way to the next largest debt, and so on. This is a great way to motivate yourself to pay off your pending loans.
However, if you want to save money right off the bat, you can use the Avalanche Method of debt payments. This prioritizes the loan with the highest interest, ensuring it is paid off first before moving to low-interest loans.
Round up your payment to the nearest $50
If you feel it’s unlikely you can make any extra payments in a year, commit to rounding up your monthly payments to the nearest $50. For example, if your payment is $207/month, round it off to $250. This is a small enough increase that it doesn’t affect your monthly finances, but will still help you cumulatively repay the loan quicker.
Use pay raises/bonuses/refunds to pay off your loan
Your finances are usually a test of your willpower, and it is most tested during a pay raise or bonus! If you find yourself getting windfall gains at work, put them to work by making as many extra payments on the car loan as you can. While it may hurt not to increase spending in the short run, you can get more savings in the long run by closing the auto loan sooner
Earn additional income
If you can’t find extra money in your budget to put toward your car loan, think of creative ways to make some extra cash. This could mean selling or renting things you own or getting extra work. Here are some options:
- You could rent out a room in your home.
- Help friends and neighbors with their yard work.
- You can sell things like old musical instruments, tools, jewelry, and workout gear on the Internet.
- Take on a short-term job that pays tips, like ride-sharing or working in a restaurant.
- Try to find a new job or talk to your boss about a raise or promotion.
Pay each month
You should still pay your loan every month, even if you are ahead of schedule. This will stop interest from building up, so more of what you pay goes toward the principal, and less goes toward interest. And making regular payments even when you don’t have to will help you pay off your car loan faster.
When should you not pay off your car loan early?
If you pay off your car loan early, you’ll have a few hundred dollars more every month. But in some situations, you could hurt your finances more than help them. So, it might not always be the best thing to do. Don’t pay off your loan too soon if your loan situation falls under any of the following:
If there is a prepayment penalty
You have to pay a prepayment penalty if you pay off your loan early or make extra payments. It’s the lender’s way of making up for the interest you would have paid on time. If there is a penalty for paying off the loan early, make sure it won’t cost you more than the interest you would pay otherwise.
If you signed up for a pre-computed interest loan
With precalculated interest, more of the interest you pay each year is due in the first month than in the last month. Paying off your loan early won’t make a big difference in how much it costs. In this situation, it is best to follow the loan schedule.
If you don’t have much debt
Even though it might not make sense, your credit score is based on your debt types and how long you’ve had them. Since car loans are long-term debt, making regular payments for years will help keep your credit score high.
One thing to keep in mind is that paying off your loan could lower your credit utilization ratio, which makes up about 30% of your credit score. If you have other debts and a high ratio of debt to income (DTI), getting rid of one account should help your score.
How to lower your monthly car payment
You can defer your payments if you don’t want to refinance your loan. With deferment, you can skip a payment if you are having short-term money problems. Lenders may give you an extra one to three months to pay back your debt. But deferring your payments just moves them to the end of your loan, so you will still have to pay them back. You will also have to pay interest so it will cost you more in the long run.
Your loan may be harder to change, but it doesn’t hurt to ask. Loan modification is similar to refinancing in that it changes the terms of your loan by either making it last longer or lowering your interest rate. If you can get your loan changed, you might be able to lower your monthly payment without needing to find a new lender.
