In 2022, the average price for a new car increased by 4.2% over the year before, coming in at just under $50,000. As a result, consumer reliance on loans and financing to purchase new vehicles has also increased. For those in this situation, it’s important to remember that as you pay back the loan, you’re not just paying for the value of the car (the principal) but also servicing the interest attached to it.
These interest payments can add up fast. The average auto loan interest rate for a new car in 2022 was 4.07%. Therefore, one can expect to pay about $2,000 in interest for an average priced, new automobile. While that may seem like a large amount of money, there is one way you could potentially reduce that amount: paying off the loan faster than scheduled.
Because interest is charged on a monthly basis, making early payments on the principal could potentially reduce the amount you spend on the loan over its lifetime. This strategy may not be an applicable solution for everyone, but if the terms of your agreement allow it, it can be an excellent option for saving money in the long run.
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How to Pay Your Car Fast
If paying off your car fast is an attractive option to you, there are a variety of actions you can take to achieve that end. Here are a few of the most effective methods:
Refinance With a New Lender
If you had less-than-perfect credit when applying for your initial loan, you might have had to settle for unfavorable loan terms like a higher interest rate or extra fees. If you’ve been paying your bill on time or your credit score has increased in tandem, refinancing your loan with a new lender will help you secure a lower interest rate and new loan terms.
For those looking to pay their auto loan off faster, refinancing can potentially bring another benefit: reducing the loan’s payment period. If your original loan was obtained with lower financial indicators, your lender might have assigned you a longer payment period, perhaps up to 60 months. Longer payment periods require lower amounts due each month; however, you ultimately pay interest for longer. If you can qualify for refinancing, that shortens the payment period, perhaps to 24 months, you will pay more upfront but ultimately pay less interest overall and finish the loan quicker.
Make Bi-weekly Payments
If you’ve been comfortable paying your monthly bill, you might consider switching to half payments every two weeks. Each year has 52 weeks, which means you’d be paying 26 bi-weekly half-payments–equivalent to 13 total monthly payments per year.
While this might seem like a marginal adjustment, this one extra month per year would cut six months (and the attached interest) off a six-year loan. Every payment would also knock down your principal, which in turn would diminish the interest owed. Paying bi-weekly will shorten your loan term and lower the monthly interest paid.
Round Up Your Payments
Any extra money you can spare each month will go a long way in expediting the loan process. For example, say you took out $15,000 at a 5% interest rate with a $211 monthly payment. Rounding that payment up to $250 a month would cut more than a full year off your loan and save you close in interest.
If your budget has some flexibility, that extra $39 each month could go a long way toward reducing the total amount owed. While rounding your payment up to the nearest $50 or $100 interval would go a long way, even rounding up to the nearest $10 will cut some time off your loan and save you on interest.
Review Additional Car Expenses
Sometimes lenders roll additional expenses into your initial loan without your realizing how much they’ll cost you over time. Look over your loan documents for any of the following:
- GAP (guaranteed asset protection) waivers
- Extended warranties
- Service contracts
- Tire and wheel warranties
While each of these add-ons can serve to help you in its own way, you may not need them. Canceling some or all of these add-ons will not only lower your monthly payment or principal but could also result in a partial refund credited to your loan account.
Make a Large Additional Payment
Say you unexpectedly fall into some windfall profits, perhaps through a tax return, holiday bonus, or inheritance. Routing some of this toward your auto loan in one sizeable additional payment will significantly reduce your loan balance and save you hundreds of dollars in accrued interest.
Paying extra on your car loan, no matter how much or how little, will help save you on interest over time. Check-in with your lender to ensure the additional loan payments credit your principal, not just the interest rate.
Don’t Miss a Payment
Some lenders might allow you to defer payment for a few months if you feel your budget is tight. While this could seem alluring to someone faced with the financial strain of a car loan, skipping payments will only lengthen your loan and cost you more on interest in the short and long term.
If your lender does not allow deferment, missing a payment would result in late fees and set you back from your ultimate goal of paying your auto loan off faster.
How to Decide Whether to Pay Your Auto Loan Off Early
Before paying off your auto loan early, determine whether your lender will allow it. Lenders profit from years of accrued interest on a loan, and some will take measures to prevent you from paying it down too fast.
After investigating your loan terms, calculate how much you’ll save and inquire how an early payoff might affect your credit score. While credit aggregators do not look kindly on those with large amounts of debt in relation to their income, they also may reduce your score if you pay off your loan too quickly. If paying your loan off too early would yield a negative or neutral impact on your credit indicators or finances, you should pay the loan by the terms dictated in your financing contract.
Determine Whether You’re Allowed to Pay It Off Early
Even if your financial institution allows an early payment, you should watch out for pre-payment penalties. These fees pop up in some loans and neutralize any gain achieved by paying your loan early, negating any positive effects.
You should also check that any additional payments you make go toward your principal, as some lenders automatically apply surplus cash toward interest or other fees. Other financial institutions hold that extra money for your next monthly payment. Make sure to communicate with your lender to ensure they put your money in the right place.
Calculate How Much You’ll Save
After investigating your loan, you can utilize a free online auto loan calculator to accurately determine how much you’d save by paying your loan off faster. Factor in pre-payment penalties and other fees that would offset your potential savings. If this final number projects as minimal, the long-term reward may not prove worth the financial stress of paying early.
On the other hand, paying your car loan off faster should save you enormously on interest by the end of the loan. Just ensure the money you save in the long term makes up for the impact on your daily interim budget. Do not compromise your daily security for pennies on the dollar.
Will it Affect Your Credit Score?
Paying off your auto loan too fast can sometimes negatively impact your credit score. Lenders look more favorably on open credit accounts in good standing than on closed accounts. Fully paying off a debt lowers your credit mix and the number of open accounts in your name, temporarily lowering your credit score.
This credit dip would only register briefly, and your score should bounce back after a few months. Your credit score might remain the same if you already have other obligations loans like mortgages, student loans, personal loans, and credit cards.
When You Shouldn’t Pay Your Auto Loan Off Early
As previously stated, quickly paying off an auto loan might not make sense for everyone. You should refrain from paying your loan off early if:
- Your loan has pre-payment penalties. Some lenders add stipulations in the loans’ termsthat nullify any money you’d save through an early payment.
- You cannot afford to pay early. Stretching your income too far to pay off an auto loan could deepen your debt by leading you to default on other loans or resort to new lines of credit. You should refrain from paying too fast if you think you may make your financial situation worse.
- You have other high-interest debts. Auto loan rates can run lower than many credit cards, student loans, or other financing plans. Prioritizing these higher-interest debts over your auto loan will ultimately save you more on interest over the long term.
When You Should Pay Your Auto Loan Off Early
On the contrary, many situations exist in which you might benefit from paying your loan early, including:
- If you recently come into some extra money: Occasionally, individuals receive a lump sum of money from sources such as a tax return. If you find yourself in that situation and can now pay your loan early without straining your budget, you may want to do so.
- You want to free yourself from debt: Your car turns from debt into an asset after paying off your loan, increasing your credit score, and freeing up money for other purchases.
- Your loan has a high-interest rate: If you had poor credit when applying for your car loan, you might have had to settle for an unfavorable interest rate. The faster you pay off this high-interest loan, the more you’ll save on interest over time.
- You have a variable-rate auto loan: Variable-rate loans fluctuate based on market conditions, such as federal interest rates. Considering that interest rates may continue to increase for the foreseeable future, paying your loan off quicker could negate the effects of broader economic headwinds on your monthly finances.