Is your monthly car payment a burden on your budget? Paying off your car loan early can bring you much-needed financial freedom and may save you hundreds (or thousands) of dollars in potential interest.
There are several effective strategies you can use to pay off your car loan early, but before doing so, please consider any potential penalties and impact on your credit score.
The true cost of car loans
It’s no secret that cars are our worst big investment. Unlike houses that usually increase in value over time and education that theoretically opens the door to increased income potential, cars lose value over time. In fact, a new car will depreciate once it’s out of the lot, and will depreciate by 20% to 30% in the first year.
This is a big deal, especially considering the average cost of Americans buying a new car in 2021. According to KBB, This hard-to-swallow figure exceeds $40,000, an increase of more than 4% over 2020.
This means that Americans will spend $40,000 to buy a car, which is worth between $28,000 and $32,000 a year later, which is equivalent to a loss of $8,000 to $12,000.
But it’s not just the price to consider. In addition to sales tax (10.12% on average In 2020, although it varies from state to state), be prepared to pay the interest on your car loan. Currently, the average car loan interest rate (also known as APR, annual interest rate, although there are differences) exceeds 4%.
APR includes interest rates, as well as other expenses, such as loan origination fees or mortgage insurance. When calculating the fees you pay, you should use APR instead of a fixed interest rate.
Your APR will depend on the current market and Your credit scoreThe higher your credit score, the lower your APR. If your credit score is weak and you can postpone buying a car, it is recommended that you establish your credit score before applying for a loan.
In 2021, the interest rates for 48-month (four years) and 60-month (five years) loans are expected to hover between 4% and 5%.
Car loan calculator: an example
The interest on the car loan adds up. Let’s take a $40,000 new car as an example, and the dealer fee is $995. Suppose you deposit 2,000 USD, the tax rate is 10%, and the annual interest rate is 5%. You have agreed to repay the loan within 60 months or 5 years. (The typical auto loan period is three to seven years; the shorter the loan period, the higher the monthly repayment amount.)
In this case, the total vehicle cost after taxes and dealer fees is $44,995, minus your $2,000 down payment. The remaining $42,995 requires financing. Given that the 60-month interest rate is 5%, your monthly payment will be $811.37.
Over 60 months, you will eventually pay $50,682.20 (including down payment) to buy a car, plus taxes and dealer fees, for only $44,995. This means that you paid $5,687.20 in interest for more than five years.
Let’s ignore the fact that due to depreciation, the car you just paid for more than $50,000 is now worth only $18,752.41 (average value 37% of original cost Five years later).
Use Penny Hoarder’s car loan calculator to figure out how much you will pay with real numbers that match your scenario.
How car loan interest rates work
If you can afford it, paying off your car loan as soon as possible may seem like a breeze. However, before you start to develop a strategy for how to pay off your car loan in advance, do some digging to determine what kind of car loan you have.
In an ideal world, your loan would be a simple interest loan. If you have not yet purchased a car, only consider lenders who provide you with simple interest loans. This means that the interest is calculated solely based on the principal balance of the loan.
However, if your lender charges pre-calculated interest, it means that they will calculate the amount of interest you paid during the loan term and count it into your total balance. This means that even if you pay off the car early, the repayment offer will include all the interest you should have paid while keeping the loan outstanding. In this case, there is absolutely no financial savings in paying off the car loan early.
Another element of the loan used for research is the repayment penalty. Payment of fines is legal in 36 states, allowing lenders to charge you a fine for paying off the car loan early (usually a fixed percentage of the remaining balance). In this case, it may be more expensive than the interest you paid during the term of the car loan.
Paying off your car loan early can hurt your credit score
Paying off your car loan early is unlikely to hurt your credit score, but can Keep you away Increase your credit score. Regular and on-time payment accounts for approximately 35% of your FICO credit score, Making it the most important factor. Paying a car loan every month is a good way to show the lender that you are responsible for repaying the debt.
In addition, lenders like to see a good credit portfolio (mortgage, Car loans and credit cards are the three major). Keeping your car loan open can also help extend your credit history. If you don’t have other outstanding credits (such as a credit card), and if you eventually plan to buy a house, keeping your car loan open may help improve your score.
5 strategies to pay off car loans early
If you have a simple interest car loan, your credit is good and your loan has no repayment penalties, it may be wise to pay off your car loan early. Not only can you avoid spending a lot of money on interest, but you can also get hundreds of dollars in financial freedom in your monthly budget.
The best advice to pay off your car loan early: Think of it as a mortgage. If you are a homeowner, you may have heard that paying an additional (13th) payment to your mortgage principal each year can reduce your loan by several years. If you pay more principal each year, you can easily reduce the 30-year mortgage to 15 years, and you will be able to lower the PMI (Private mortgage insurance) Cost is much earlier.
Of course, home loans are often much larger than car loans, so the potential for savings is much greater, but the logic is the same as your car loan.
These strategies are Early return All are valid, if done right:
1. Pay a large additional fee each year
If you can count on your grandma to put a thick check on your Christmas card every year, don’t use the money to splurge on alcoholic eggnog (well, maybe a bottle). Instead, apply it directly to your car loan as a one-time payment.
If you have scheduled an automatic transfer online, you can log in to your account and simply schedule a one-time payment.If you are old-fashioned and pay by phone or email, just call your lender and let them know that you want an additional one-time payment To the principal.
Apply this logic to any funds that are not budgeted (also called unplanned), such as work bonuses or tax refunds.
2. Pay half every two weeks
Talk to your lender and see if you can change to a biweekly payment instead of a monthly payment. If your lender allows you to pay half of the monthly loan amount every two weeks, you will end up paying 26 and a half. Divide 26 by 2, and you will get 13 full months of payment, paid within 12 months. This means that by the end of this year, you have basically paid for the additional car expenses.
Just check your budget first to make sure this payment plan is feasible.
If it can swing, round to the nearest $50 or even $100. This is a good way to add additional funds to the principal every month. For example, if your monthly payment is US$337, you can round it to US$350 or even US$400, which is basically an additional monthly payment of US$13 or US$63. This will eventually shorten your loan term by a few months.
If you have arranged an automatic transfer, please log in to your loan platform to see if you can add additional funds to the principal every month, so you don’t even have to think about it.
4. Resist the urge to skip payments
Some lenders may let you skip payments once or twice a year. They are so nice, right? Incorrect. They do this knowing that it will extend your loan term, which means they will earn more cash from your hard-earned interest.
Unless you are experiencing a very difficult period, resist the urge to skip the payment. If you do this, you will end up paying more.
5. Refinance, but proceed with caution
If you have a poor credit score when buying a car and choose a seven-year loan to keep the repayment low, Refinancing may make sense. Maybe you have been loaning for two years, you have a higher-paying job, and your credit score is also very good. You may refinance with a lower APR and establish a loan within 36 months, saving you two years of time and a lot of interest.
But the borrower should pay attention: do not refinance by extending the loan to get a lower monthly repayment amount, because you will only pay more interest in the end.
When you shouldn’t pay off your car loan early
As we have seen, paying off car loans early does not always make sense. However, in addition to paying fines and pre-calculated interest, there are more reasons to own your horse.
Here are some other reasons Is not Pay off the car loan in advance:
- Lack of emergency savings. Bankrate reported in early 2021 that most Americans cannot afford a $1,000 emergency. Only 39% of people have enough money to cover such unexpected expenses.If you are part of that 61%, no Sufficient emergency fund, Prioritize adding funds to high-yield savings accounts to protect yourself and your family in the event of unimaginable situations. This is not just a medical emergency for your family; if your dog ate something that shouldn’t be eaten, you may need to pay a deductible for your renter’s insurance, just in case, unexpected car repair costs, or even A terrible veterinary journey.
- High-interest loans. If your car loan interest rate is reasonable, but Drowning in credit card debt, Focus on debt with the highest interest rate. Historically, the interest rate on credit cards is in the teens, so it makes the most sense for them to pay off first. If you have no credit card debt but have a mortgage or student loan, compare these interest rates with the interest rates on your car loan to find the most reasonable way to repay the loan with additional funds.
- Lack of credit history. If you refuse to get a credit card and do not have a house yet, then a car loan is your best option to build a credit score. Keeping your car loan open may have a positive impact on your credit score.
- investment. For most drivers, car loan APR is not Terrible. If you have some additional funds and are considering repaying a low-interest car loan, please consider Invest in your retirement fund Even buy a few stocks by myself. The average return on the stock market is about 10%.Obviously you can end Lost Money, but in general, if you invest and hold, you should expect your money to grow over time.
Timothy Moore is the executive editor of WDW magazine and a freelance writer and editor, covering topics such as personal finance, travel, career, education, pet care, and automobiles. He has been working in this field since 2012, including publications such as The Penny Hoarder, Debt.com, Ladders, Glassdoor, Aol, and The News Wheel.