The Best Practices For Paying Your Car Loan Off Early
Paying off your auto loan quickly is one of the best choices you can make to keep your finances stable for the long-term. Your first thought might be that there’s no difference between paying the price of a vehicle now and paying that same price later; but that’s not how it actually works. When you’re paying off car loans, you’re dealing with interest payments and car value depreciation. Every auto loan has interest rates that come with it usually referred to as an annual percentage rate (APR). The longer the loan lasts, the more you will pay in interest while at the same time your car’s value depreciates.
For example, say after making a down payment of $2,000 on a car priced at $12,000, you take out a $10,000 loan with 5% APR to pay off the rest of it. The loan also has a 72-month term that comes with it. Your monthly payment would be about $161 to cover interest and principal, but by the end of your loan term all that interest will have added up to $1,596. That means you’ll have to repay the final amount of your loan at $11,596. But in the meantime as you’re paying off that loan, your car will also depreciate, so assume after those 72 months it’s now dropped from $12,000 to about $7,000. By then you’ll have paid a total of $13,596 for your car, an amount almost double its current value. That’s why you’re much better off taking on car loans with shorter terms and paying them off quickly. Here’s some of the best practices for doing so.
1. Make Sure You Buy A Vehicle With A Lower Depreciation Rate
Every vehicle depreciates, but you can minimize the loss accumulated through depreciation if you buy a vehicle with a lower depreciation rate. This could mean buying a new vehicle that will hold its value and is known to last longer and be more reliable. Or you could purchase a used vehicle that still qualifies for financing, but if it’s a few years old already, it will have a much lower depreciation rate and usually you can buy equity into it at a rate that keeps you from being upside down in payments.
2. Try The Two Payments Per Month Approach
As pointed out by HiCharlie, there is another method to paying off cars besides making one payment on your monthly due date. You can make two payments prior to that and schedule them about every two weeks. It may not seem like it’s any different than just making one payment each month, but there’s a little bit of a catch to it. For example, if you owed $300 per month on your car loan payment and it was due on the 4th each month, you could actually fare better by making two payments in the prior month. So you would stagger the payments of say $150 on the 15th of the prior month, and then another $150 on or near the final day of the month. Believe it or not, this method actually reduces your total amount of interest due and pays off the principal quicker.
3. Pay Above The Amount Due But Designate It Towards The Principal
What you should be aware of is that usually the first set of payments you make on your vehicle doesn’t reduce your loan principal. They’re usually designated to pay off interest first and then gradually reduce the principal. But if you opt to pay extra on your amount due, you can choose to have it applied to the principal which will shorten your loan period and cut down the amount of interest you pay. You will probably need to contact your lender first to make sure they do apply the extra payments to the principal and not just to the next month’s amount due. You’ll also want to make sure your lender won’t penalize you if you make these extra payments or pay off your loan early as a result.
One other way you can pay extra is by using the rounding up technique. in which you take the amount you’re paying and round it up to the next hundred dollars. So for example if you owe $317 per month on your car loan, you can pay $400 instead. But again, make sure that extra amount is going towards the principal and not next month’s balance.
4. Make Sure Your Budget Allows You To Pay Extra
While you do want to make your car payments a priority, you still need to make sure you can afford them. You can start a savings fund to allocate a certain amount of your take home pay towards paying off car expenses. You might also consider adding another job or side gig to increase your income. There’s a lot of ways you can make extra money each month, so at least consider them.
5. Look Around For Better Insurance Rates
While not directly car payments, your current car insurance rates do cut into your monthly budget and affect your overall ability to pay off your loan quicker. So if you haven’t done any recent shopping for cheaper insurance lately, The Balance recommends doing so. Along with insurance, carefully consider whether you need GAP insurance. Depending on your dealer’s requirements, you may or may not need it. But if you do, see if your insurance provider can get you the cheapest rate.
6. Carefully Look At Refinancing Options
Refinancing car loans may be the best or worst piece of finance advice. For homeowners, the opportunities to do so with a mortgage usually make sense because a home is usually a permanent asset that can increase in value. And when you come into lower interest rates, it makes sense to pay less per month on that mortgage. But with a car, you don’t want to refinance just to get lower monthly payments and interest rates with an extended deadline. You should do it if you’re able to make higher monthly payments with lower interest rates and thereby shorten the loan term. This can be beneficial if your current loan term has a prepayment penalty attached to it but you want to pay off your car early and avoid that penalty. The time to check for refinancing options might be if you’ve suddenly received a raise at work and have more money to allocate towards your car payments; or if you checked your FICO score recently and saw it improve enough to qualify for lower interest rate refinancing. Be aware that refinancing can sometimes come with hidden fees that may also factor into whether or not it’s worth it.
7. Why You May Want To Hold Off Paying Off Your Auto Loan Completely
If you’re like most consumers, chances are your auto loan isn’t the only debt you’re carrying. The credit bureaus have some unusual ways of weighting your debts, but they often dock you if you’re carrying a high utilization ratio on certain accounts. Credit cards, for example, are often where a high utilization can occur since they’re frequently used. Student loans are another example of this. If you pay off your auto loan completely but have a high debt utilization ratio on your other accounts, this could actually hurt your credit score instead of helping it. That’s because if your auto loan is low utilization debt, it can offset high utilization debt. For that reason, you shouldn’t prioritize paying off your auto loan first if it’s not accruing the most debt. Instead, focus on keeping credit card balances and other higher debts lower, and when your credit score improves then pay off your auto loan so that it improves even more.
8. Should You Should Sell Your Car To Get Out From Under Unaffordable Auto Loan Debt?
Sometimes financial hardship does happen, and it puts you in a difficult place where paying off an auto loan just may not be feasible anymore. At that point, you may wonder what your options are. If you’re able to sell your vehicle at a price that’s higher than what you currently owe on it, consider selling it and then using the difference to either buy a more affordable car outright in cash, or perhaps make a down payment on another vehicle that you know you can make auto loan payments on and pay off very quickly.
But what if you are upside down in your auto loan payments? You still may want to sell it if the difference you’re on the hook for isn’t that much and you know you could pay it off quickly. But also bear in mind that you can look at resources like the Kelly Blue Book and see what its real market value is. Using that information, you may be better off selling it yourself to a private buyer if you can get more than the dealer is willing to pay.
So You’ve Paid Off Your Auto Loan, Now What?
So now that you’ve finally paid off your car and own it outright, it certainly can feel like a huge weight of debt is off your shoulders especially if you paid it off early. And if your credit score has gone up, that’s even better. But a good piece of financial advice to remember is that keeping a car running long-term requires other obligations as well.
1. Make Sure You Set Aside Money For Regular Maintenance
Since a car always depreciates and never gains in value, you need to make sure you maximize its lifespan by keeping it well maintained at all times. Make sure you take it to the vehicle’s dealership or a highly trusted mechanic to get its scheduled oil change. A highly skilled mechanic who does this will usually perform other checks on the vehicle while it’s in the garage, and they can let you know if you need extra maintenance done.
2. Consider Other Ways To Save Your Extra Money
If paying off your car loan early has netted some extra dollars back to your pocket, don’t just use them to go on a big vacation as tempting as that may be. They may be put to better use in an emergency savings fund; especially one that can be used in the event your car breaks down on the roadside and you need money to pay the towing bill or mechanic’s garage. But even if not, other long-term financial goals such as 401k investments can benefit from a sudden influx of money.
3. Don’t Forget Your Title
Once you own your vehicle completely, you need the official document stating you own it known as the title. Some states have auto loan lenders hold the title while the car is being paid off, and then once it is paid off the lender notifies the DMV to send you the title by mail. But some states actually give you the title with the lender listed as a lienholder on it. Once you pay it off, you’ll want to contact your state’s DMV or go to the local office with the appropriate paperwork so they can update your title as clear.