Why Paying Down A Car Loan Can Be A Good Approach
Experts say that paying off a car loan early can be a smart approach if you’re able to afford it. “It’s always a good idea to pay down your loans and a car purchase is probably one of the biggest loans that people take out short of a home purchase, so it’s a good place to start,” says Ronald Montoya, senior consumer advice editor with auto research company Edmunds.
Beyond peace of mind, there are tangible benefits to paying off your car loan, Montoya says. For one, it could save you money on interest, especially if you have a 60-, 72- or even 84-month auto loan.
Say you took out a $30,000 loan with a 6-year repayment term and a 5% interest rate. You’d end up paying nearly $35,000 in total . But if you pay off that loan early, you could cut back on some of that interest.
Paying off your car loan can also take pressure off your monthly budget, Montoya says. After your car is paid off, you now have extra money you can use to pay down other debt, increase savings or put toward expenses.
But before starting to pay off a loan early, consumers should check to see if their lender even allows it, Montoya says. “Make sure that you look into what fees they would charge if you pay down your loan early,” he says, since some lenders charge a prepayment penalty.
Determine Your Current Balance And Payoff Penalties
The first step when deciding whether to pay off your car loan faster is to look at the details of your loan. Some lenders make it difficult to pay off car loans early because theyll receive less payment in interest.
If your lender does allow early payoff, ask whether theres a prepayment penalty, since a penalty could reduce any interest savings youd gain.
Then, check your balance and make sure that any extra payments go toward the principal on the loan. Some financial institutions will automatically apply additional payments toward interest or other fees, rather than toward reducing the principal, or theyll hold the funds as a credit toward your next payment. You may have to specify that the extra money is a principal-only payment, so run it by your lender first.
Make A Payment Every Two Weeks
Submitting payments every two weeks on your vehicle instead of monthly can also help you pay off the loan a little earlier. By paying half of your monthly payment every two weeks, you end up making a total of 26 payments per year, which is equivalent to making 13 monthly payments in one year rather than 12. Contact your lender to make sure this is an option and for their assistance in setting it up.
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Ways To Pay Off Your Car Loan Early
Using these 7 strategies can help you pay off your car loan early and save on interest.
1. Refinance your loan
If you find yourself in a better financial position than when you bought your car, and you have a strong credit score, you could refinance your car loan to get a shorter term with a better rate, which will help you to pay off your debt faster.
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2. Make additional payments
If allowed, try to make additional payments whenever possible. Making payments every other week, as opposed to twice a month, adds two extra payments per year , which will help you save on interest.
3. Make lump sum payments
Try to make a few large payments per year when you get extra cash from a bonus, tax refund or a pay raise. Or lets say that you come in under budget for some other expense, consider putting that extra amount on your car loan too.
4. Get a side gig
Working a few extra hours on the side can help you save up the cash you need to pay off your car early. Even small savings can really add up.
5. Renegotiate your car insurance
There could be additional savings if you start comparing other car insurance options, especially if you have a record of good driving. Then just apply the money you save to your car loan.
6. Sell your junk
7. Dont skip payments
What Is A Prepayment Penalty
Theres a lot of fine print on a loan contract that outlines all the nitty-gritty about your obligations, which is why its important to read your contract in detail before you sign on the dotted line. And among all the details of the contract to pay attention to, prepayment penalties are an important one.
A prepayment penalty is exactly what it sounds like: a financial charge that you would be subject to if you pay off the loan in full before the maturity date. Lenders like making loans because they make money on interest, so if you pay the loan off early, that profit would be slashed. And to recoup their losses, they may charge a prepayment penalty.
The prepayment penalty rate and whether or not one exists at all will be specified in your loan contract. That said, penalties are usually smaller the less you owe and the longer youve had your loan. Be sure to find out if a prepayment penalty provision exists on your contract and how much you would be charged if you pay off your loan before its original due date.
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Our Recommendations For Refinance Auto Loans
A refinance auto loan may be a great way for you to pay off your car loan faster as long as you secure affordable rates with a reputable lender. Sourcing quotes from providers allows you to compare them and see who offers the best refinancing rates for you. We recommend starting your search with one of the following providers from our list of the best refinance auto loan companies.
How Does Paying Off A Personal Loan Early Affect Your Credit Score
When you pay down your credit card balance, you lower the amount of credit card debt you have in relation to your total credit limit. This means your utilization rate, which makes up 30% of your credit score, is lowered and it can help you give your credit score a little boost. So shouldn’t the same be true when paying off your personal loan?
According to Experian, personal loans don’t operate the same way because they are installment debt. Credit card debt, on the other hand, is revolving debt, which means there’s no set repayment period and you can borrow more money up to your credit limit as you make payments. Installment debt is a form of credit that requires you to repay the amount in regular, equal amounts within a fixed period of time. When you’re done repaying the loan, the account is closed.
When you take on a personal loan, you add to the number of open accounts on your credit report. The loan can also improve your , which makes up 10% of your FICO score. But when you pay off an installment loan, it appears as a closed account on your credit report. Closed accounts aren’t weighted as heavily as open accounts when calculating your FICO score, so once you pay off your personal loan, you’ll have fewer open accounts on your credit report.
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How To Pay Off Your Car Loan Early
Once you weigh out the benefits and drawbacks, you can decide whether its a good idea to pay off your car loan early. If you decide it makes sense for you, youve got a couple options for paying off your loan ahead of schedule.
One way to pay off your car loan early is to make one lump payment. Contact your lender to find out your car loan payoff amount and ask how to submit it. The payoff amount includes your loan balance and any interest or fees you owe.
You can also pay more than the minimum amount due each month. Making at least one extra payment on your loan every month, or adding more money to your monthly payment, may help you pay off your car loan early. But if you plan to go this route, ask your lender to specifically apply any extra payment to the loans principal.
Reduce Your Car Insurance Cost
Once your car loan is paid off, you can reevaluate your car insurance coverage. If you have paid for your vehicle through financing, most lenders require you to pay for full coverage car insurance as well. Now that your car is paid off, you have options.
Option 1: Keep your car insurance coverage as is. It may not save you money but if your vehicle is damaged in a car accident your car insurance can help repair the damage.
Option 2: Remove collision coverage. Collision coverage is the coverage you need when you damage your vehicle and it was your fault. It can also potentially help when someone damages your parked vehicle. Collision coverage is often the most expensive coverage. Take a look at your potential for an accident, how much your vehicle is worth, and how much the coverage costs. With all three of those pieces of information, you should be able to determine if the coverage is right for you. If you cannot decide, get some advice from your agent. Agents often do not tell you what to purchase but can offer guidance in the decision-making process.
Option 3: Remove comprehensive coverage and collision coverage. Comprehensive coverage protects against fire, theft, vandalism, flying objects, deer, weather, and more. Removing comprehensive coverage would leave you with no physical damage coverage on your car insurance policy.
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Pay It Off In A Partial Lump Sum
If you dont quite have enough to pay off the balance in full, you may make a large payment to pay down a big chunk of it. This wont reduce your monthly payment, but it can significantly cut down on how long youll be in debt. And since it will go toward the principal, youll wind up paying less interest overall.
If Your Lender Wont Accept Principal
If your lender will not accept principal only payments, you have two choices:
- Refinance the loan with a lender who will accept principal-only payments. Make sure that you get written verification before doing the refinance. You can get multiple different no-obligation auto loan refinancing quotes from Monevo online with just one simple application.
- Make your additional principal payments to a dedicated savings account, and when the savings account balance is high enough, pay off the loan completely.
But before you do any of that, check to see what the laws are in your state in regard to principal-only car-loan payments. If your lender doesnt allow it, but state law does, you can cite the law and require that they make a provision to accept the payments.
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How Much Can I Save By Paying Off My Car Loan Early
How much you can save depends on several factors, including how much time you have left on your term, your loan balance and your interest rate. Use our car loans calculator to learn the difference between repaying your loan according to your current term and paying it off early if you have no prepayment penalties.
What Is The Rule Of 78
Early redemption or early payoff calculations for car loans in Singapore are based on a system called Rule of 78. This is basically a method used to calculate interest charges on a loan that would be repaid earlier than usual.
Rule 78 is named as such because a 12-month loan would have interest payments depending on the proportion of the month that payment was completed. As there are 12 months in a year, adding the ordinal designator of the month would yield a result of 78 hence the name.
Formula: 12 + 11 + 10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 = 78
This means the amount of loan interest paid for the eleventh month would be twice as high as the one that would be paid by the twelfth month, while the loan interest paid for payments in the first month would be twelve times higher than the payments for the twelfth month.
Example: If you have settled the loan on the ninth month, then your interest rate fraction would be 10/78 as paying on the ninth month means your loan interest is four times as high as the interest for the twelfth month. The numerator is based on 4+3+2+1 = 10.
Under this example, paying earlier like into the third month of the loan which will yield a bigger interest rate fraction of 55/78 or a higher interest payment.
This means that it is possible to settle a car loan earlier like paying it off four years into a seven-year car loan but you may not save a lot. Therefore, complying with the existing loan tenure may be a better option for some.
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Simple Interest Vs Precomputed Interest
As already mentioned, loans come with interest rates to give lenders a stream of income. The rate youre charged will depend on a few things, such as your credit score, the loan amount you require, the loan type, the collateral , and the lender. But there are variations of interest that you should be aware of.
Since saving on interest is one of the main reasons why someone would want to pay off their loan early, its important to understand what the difference between simple and precomputed interest is. More specifically, understanding these types of interest may influence whether or not you decide to pay off a loan early, as well explain.
Check out our article, Interest 101, for even more information about interest rates.
Simple interest Simple interest is paid on the principal amount that is taken out. It is not compounded. So, if you take out $5,000, for instance, youll only pay interest on that $5,000 without any compounding involved. Its the fact that the interest is not compounded which makes simple interest attractive to borrowers.
Since each payment on a loan with simple interest charged reduces the principal amount by a certain margin, the principal amount will be lower on the next payment compared to the previous payment. As such, less interest would be due on the principal amount while more of the payment would go toward paying down the principal. Mortgages and other conventional installments loans work this way.
to find out.
Can You Pay Off A Car Loan Early
First, lets start by taking a look at your car loan.
While youre probably already making payments toward your car, its important to know that a car payment is considered too high if it makes up more than 30% of your total income. Make sure to also factor fuel and maintenance expenses into this number, as a car payment wont be your only vehicle expense. Generally speaking, try not to let your car payment exceed 15 20% of your total income.
After reviewing your car payment, determine your loans current balance and confirm whether you can pay off your car loan early without penalties. While most loans do allow early payoffs, some might impose extra penalties, which would ultimately cost you more money in the long run. Make sure to pay extra attention to penalties if you have bad credit or a high interest rate.
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The Pros And Cons Of Paying Off A Car Loan Early
Paying off a car loan early can be a great idea. Sometimes it might make sense, and other times there are better ways to spend or save any extra money. Like all major financial decisions, you may want to discuss with a financial professional and weigh the pros and cons of paying off a car loan early before jumping in.
Paying Off Your Car Loan Early
If you are currently financing a car or are planning to take out a car loan soon, heres a tip you may not realise: you can pay off your loan early if desired.
Paying off auto loans ahead of schedule can provide numerous benefits for your financial situation. While some lenders charge penalties for early repayments, the benefits outweigh the cons in many cases.
Read on to learn the answer to Can car finance be paid off early? Then check out our Westside Auto Wholesale financing page to learn more about our car financeoptions.
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The Ultimate Opportunity Cost
So, should I settle my loan early? To answer this question it depends on what your opportunity cost is when you choose to prepay.
In my choices above, I wont prepay if I can use the capital to generate higher returns elsewhere compared to the interest rate that I am paying for.
The ultimate opportunity cost here is this getting a loan allows you to use less capital to acquire an asset in exchange for paying an interest rate.
If I have RM100,000, I can use RM10,000 to pay for the downpayment of a house worth RM100,000.
I could borrow RM90,000 with an interest rate of 3%, but use this RM90,000 to invest into a REIT that pays out 5% dividend yield.
From this 5% return, I pay the loan of 3% and I still have 2% in returns that I can reinvest to get more returns.
Essentially, I own a house with RM10,000, and RM90,000 worth of REIT shares and generate a net return of 2% on the RM90,000, which will be compounded.
And this is without renting out the property. Its a simple example, but it showcases the power of using loans the right way.
The other option is using RM100,000 to buy the house in cash. I now have a house and no cash or extra investments. Are you seeing what I see?