- Life & Money
- Everyday Money
- Managing Debt
- Tim Stobierski
- Oct 18, 2017
How to Pay Down Your Car Loan Wisely
Most people think of car loans as a necessary evil in life. It’s rare that anyone has enough cash in the bank to buy a car without a loan (especially a new car). Though you might not want to take on debt to buy your car, if you’re like a lot of Americans, chances are good that you don’t have many other options.
But when it comes to car loans, it pays to remember that they are considered “bad debt,” just like credit cards. This is thanks, in part, to the fact that a new car will be worth less than you paid for it as soon as you drive it off of the lot.
The good news is, you don’t need to be trapped by a car loan forever. By paying down the loan ahead of schedule, you can get rid of your monthly payment sooner and save money in the form of interest at the same time — a win-win.
Wondering where to start? Here are five strategies.
By paying down the loan ahead of schedule, you can get rid of your monthly payment sooner.
PAY MORE THAN THE MINIMUM
The simplest way to pay down your car loans is to make sure that you pay more than the minimum payment each month.
You can do this easily by rounding up your payment every month. For example, if your minimum monthly payment is for $265, rounding your payment up to $300 will help you pay off an additional $35 of loan principal — the total amount you still owe — every month. That’s $420 over the course of a year, and $2,100 over the course of a typical 60-month loan. Rounding up also means you’d be able to pay off your loan about seven months faster.
So if you have room in your budget to pay even more and you’ve got no other higher interest debt to take care of, go for it: You’ll reduce your principal faster.
MAKE BIWEEKLY PAYMENTS
Typically, you pay your car loans according to a monthly schedule, meaning that you make 12 payments each year. But if you follow a biweekly payment schedule instead, you’ll make a half payment every two weeks instead of one full payment each month.
Ready to take the next step? A financial advisor can show you how all the pieces of your financial plan fit together.
Because there are 52 weeks in a year, you’ll be making 26 half-payments each year, which equals 13 full payments. You’ll have made a whole extra payment on your car loan.
USE WINDFALLS TO YOUR ADVANTAGE
Unexpected money can come from a bonus or raise, a larger tax refund than you expected, an inheritance or even a generous birthday check from grandma.
Wherever it came from, you can use that “found money” to help pay down your car loan. Since it was never a part of your budget to begin with, you can use it to reduce your principal without feeling the pinch in other areas of your life.
REFINANCE TO A LOWER INTEREST RATE OR SHORTER TERM
In essence, refinancing entails taking out a new loan so that it can be used to pay off an existing loan. For the process to be worthwhile, the terms of the new loan should be beneficial in some way. (Otherwise, why go through it at all?)
There are two ways that refinancing to a new loan can help save you money over the life of your car loan. The first would be if refinancing allowed you to pay a lower interest rate; the second is if it allowed you to pay back the loan over a shorter term. Your monthly payments could be higher under the new loan agreement, but you’d be paying the loan back faster — which may mean paying less in interest over the life of the loan.
READ THE FINE PRINT BEFORE YOU SIGN
Though paying down your car loans ahead of schedule generally comes with big rewards, it can also carry with it some penalties that reduce the amount of money you save.
Typically, these penalties and fees are built into your loan agreement. If that agreement mentions a “prepayment penalty,” you will most likely be required to pay a predetermined fee to pay off your debt early. Depending on the penalty, paying the loan back early may not make sense.
You must also keep in mind the structure of your loan. If your loan calls for “precomputed interest,” paying the loan off early may not save you any money at all. In this type of loan, the interest is a fixed amount that is determined and added to your loan at the beginning of your agreement. This means that no matter how quickly you repay your loan, you will be required to pay the interest in full. (Note: This type of loan can also be called an “add-on interest loan.”)
If on the other hand your loan is of the “simple interest” variety, then you can pay off the loan as quickly as you’d like. This type of loan calculates interest based on the amount of principal that you owe at any given time. The quicker you pay it off, the more you will save in the form of interest over the life of the loan.
While it might feel good to pay off your car loan quickly, depending on your situation, it may make sense to pay off other debts first. For instance, if you have high-interest credit card debt and a low-interest car loan, you should focus on paying off the high-interest debt first.
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