Like most everyone, I hate debt, and the thought of paying off a car loan for a number of years has always left a bad taste in my mouth. While I realize that loans can be necessary to purchase a house or pay for a college education, I take issue with the idea of financing items that unequivocally lose value.
For this reason, I’ve always resolved to pay off my car loans early. Not only does this improve my monthly cash flow, but it improves my credit score as well.
Benefits of Paying Off a Car Loan Early
The bottom line is that paying off a car loan early will save you money in interest payments. Imagine what you can do with the extra money: beef up your savings account, make home improvements, save for retirement, or perhaps pay off other debts.
Taking out a car loan can also impact your credit, as credit scores factor in your level of debt. I had a credit score of 810 when I was approved for financing, and after two months of on-time payments, I checked my credit score and discovered that it had dropped 15 points. I hadn’t missed any payments, nor had I accumulated credit card debt – the drop was entirely due to the new loan I’d taken on.
I realize that a 15-point drop isn’t too bad if your score falls within the 700 to 800 or higher range. However, if your score is within the 600 range, 15 points can be the difference between a loan approval and a denial. Though your credit score will drop after receiving a new auto loan, the sooner you pay it back, the quicker you can recoup those points.
Ways to Expedite Paying Off a Car Loan
Paying cash to buy a car is one way to avoid high interest charges and years of monthly car payments. But if you don’t have the money on-hand to pay off your car in full, a few simple techniques can help eliminate your car debt faster.
1. Round Up Your Payment
Rounding up your car loan payment is an easy and effortless way to knock a few months off your car loan term. You don’t need a lot of extra money, but the more you add to your payments, the sooner you can walk away from your loan.
To illustrate, let’s say you purchase a car for $20,000 and pay 4.25% interest for 60 months. The monthly scheduled payment based on these numbers is $371. Rounding up your payment to $400 shortens your car loan by six months. Go a step further and increase your payments by $100 a month and you can reduce your auto loan term by 13 months.
2. Make Biweekly Payments
You’re only required to make auto loan payments on a monthly basis, but if you strike a deal with your auto lender, the company might allow biweekly payments.
The concept behind biweekly payments is simple, and making payments on this schedule will ultimately reduce how much you pay in interest. Submit half of your car loan payment to your lender every two weeks. Because there are 52 weeks in the year, this equals 26 yearly payments, or one extra payment per year. Using the above illustration, your payments on a biweekly schedule equal $185.30 every two weeks.
Continue with this schedule for the duration of your auto loan and you’ll shorten your loan by five months. Discuss this option with your auto lender first, and be sure to inquire about prepayment penalties.
3. Make One Extra Payment a Year
If you simply don’t have the cash flow to commit to biweekly payments, you can achieve the same results by making one extra loan payment per year. Use money from your tax refund and work bonuses, or take cash from your savings. Better yet, divide your monthly car payment by 12 and then add this total to each future monthly payment. This also results in one extra payment per year, and helps pay off your car loan a little earlier.
4. Avoid the Skip Payment Option
Some lenders will let you skip your payment once or twice a year. My lender encourages skip payment options during the month of December, and in the past, I always took advantage of these opportunities. However, each skipped payment extends your loan by at least one month and tacks on additional interest. Skip your payment four or five times during the life of the loan and you can add six months to your car term.
I’ve been rounding up my car payments since applying for my last loan, and it has brought good results. At my current rate of payments, I will save approximately $200 in interest. I realize that $200 isn’t a huge sum of money over the span of five years; however, saving $200 in interest will trim about four or five months off my car loan payment. Not bad for a technique that’s so simple.
Have you ever paid off a car loan early? If so, what techniques did you use?