When most people think of the costs of owning a car, they think about gas, repairs and their monthly car payments. But have you ever stopped to think about the interest you're paying on your car loan?
You see, your monthly car payments are broken into two parts:
- Principal: The actual amount of your payment that goes to the cost of the car.
- Interest: The amount the bank is charging you for the loan to buy the car.
The longer it takes you to pay off your car, the more interest you end up paying. And that's why so many people strive to pay off their car loans early—to save money on interest.
Most loans give you a repayment period of about five years (60 to 72 months). With an interest rate of around 4.5% (this is the current national average for borrowers with a "good" FICO score), you may end up paying up to a quarter or more of the cost of your car.
By paying off the loan quicker, you can significantly cut down the amount of interest you're forking over to the lender, and save yourself a lot of money in the long run.
Besides, why pay more for your car than you have to?
Here are eight ways to pay off your car loan early:
1. Split your monthly payments into two
Going through this whole list, there’s only one true rule you should follow. Your aim is to cut down the repayment from sixty months to as little as thirty. The only problem, then is how to achieve this goal.
The first (and easiest) way is to pay half your monthly payments every two weeks. However, this is a compromise you’re going to have to discuss with your lender, since some of them aren’t in favor of any extra payments.
If you’re able to do so, however, you’ll end up making 13 full payments every year, instead of 12.
This may seem like merely a dent to the loan, especially if you took a larger sum, but even such a small effort could potentially save you a lot of money in the long run.
For example, if you have a 60-month, $10,000 loan, you’ll save about $35 in interest, total. However, the point of this is to cut down the repayment by a month every year you have to pay.
In this case, instead of paying back in 60 months, you should be done is 54.
2. Round your monthly payments up
Another way of playing some mental gymnastics is to round up your monthly car payments to the nearest $50. Let’s take the example from above where you borrowed $10,000 to be repaid in 60 months at an interest rate of 10%
In this case, your monthly payments would be about $212. At this rate, you should be done repaying the loan in exactly 60 months with $2,748 in interest.
A simple way to cut down on this interest is to round up this payment to $250 a month. It’s effective because of the human tendency to ignore those extra digits, at the same time saving you $533.47 in interest.
It will also cut down the repayment rate from 60 to 47 months!
3. Make a large extra payment every year
If you can’t get past the hurdle of rounding up the number to the nearest $50, maybe this alternative version of the same will suffice.
For instance, let’s say you have a $10,000 car loan to be paid off at 10% in 60 months. If you make a lump sum extra payment a year—for instance if you pay an extra $500 in December, you will repay the loan in just 49 months.
In the process, this will save you $468.88 in interest.
4. Make occasional large payments
Alternatively, if you’re feeling extra motivated, you can instead opt to make occasional large payments throughout the year, rather than just one.
This is perhaps the most effective way of cutting down your loan to size. The more lump payments you can sacrifice and pay for every month, the better.
Using any windfalls like bonuses, income tax returns or gifts towards your auto loan will also help you pay the car off much quicker.
5. Don't miss any payments
Some lenders give you the chance to skip on payments for up to two times a year. However, taking this option is a pretty bad idea.
Along the same lines, try to be as timely as possible when making your payments. One of the main factors that are taken into consideration when calculating your credit score is how early you pay back the loan each month.
A lower credit score means you will get terrible interest rates in the future when you need to take more loans.
Additionally, the more payments you skip, the longer it will take you to pay. The implication of this is that you will pay even more interest than if you were to pay the minimum rate every month.
6. Refinance your car loan
Refinancing a loan essentially means negotiating a new loan in place of the current one you own. This serves a few significant advantages. It gives you the opportunity to obtain a lower interest rate, enables you to shorten the repayment time (the term), and gives you the opportunity to consolidate your debt.
Each of these motivations has their own unique advantages and pitfalls. And since refinancing your loan can cost as much as 6% of the loan’s principal, and may require extra fees, it’s important for you to examine the situation beforehand.
This way, you can determine if refinancing is the best option and if it will have any true benefit.
If not, refinancing will only serve to burden you further. For instance, it would be a pretty bad idea to lower the amount of monthly payments and lengthen the term.
Most people opt for this option not realizing they will end up paying the same principal and a lot more interest. But if your payments are just too high, then it's a viable option.
7. Check your other interest rates
If your car loan isn't the only debt you have, there's a good chance that it's probably not the highest interest loan you have.
Nine out of ten times, this honor goes to credit cards. On average, the interest rate charged by credit card providers is three times more than the average car loan interest rate.
If this is the case for you, consider paying off the credit cards before turning your attention to your car loan. Make your car loans as normal, but allocate any extra money towards your higher interest loans, especially if they have lower balances that your car loan.
This way, you’re going to both save more money and your credit score.
8. Snowball Debt Payments
If you have multiple debts, the most effective way to get rid of them is to snowball them. This method is most effective when you have car debt, credit card debt and mortgages to get rid of.
Starting off from the lowest debt, work extra hard to pour money into paying that off, all the while continuing regular payments on the rest.
Once that payment is done, take the extra money that should be coming from the paid loan, and throw it at the next smallest debt. Continue with the same procedure until you are done paying off all the debt.
Alternatively, you could pay off the debt with the highest interest rate first.
Either way, the point is to get rid of some of the debt in order to have more to pay off the rest. In the end, there’s no real difference between the two methods and they are just as effective at getting you out of debt.
Once you’re done paying off all your debt, the biggest trick will now be not getting yourself into any more.
Pay off your car loan early
Not only willing paying off your car loan early save you hundreds, sometimes thousands of dollars in interest, but it'll also take some of the financial weight off your shoulders.
The quicker you're able pay off your car loan, the sooner you'll have extra money in your account to use towards savings, investments or other things that aren't debt.