How to pay off a car loan faster
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Provided your lender doesn’t charge a prepayment penalty, paying off your car loan faster is a great way to save money. It means less interest paid — and when you finish, you should have a few extra hundred dollars in your budget each month.
But getting there can be difficult. There are a few tactics you can use to pay your loan off faster. However, even if you can, it could put you in a worse financial position if you aren’t mindful about your approach.
6 ways to pay off your car loan faster
There is no one path to paying off your car loan ahead of schedule. In fact, it makes sense to vary your approach. Once you have an idea of how much you could save, you can take advantage of a few methods to pay off your car loan faster.
1. Refinance with a new lender
Refinancing can be an easy way to pay off your loan faster. If you opt for a shorter loan term, you may be able to keep the same monthly payment — provided you score a lower interest rate. Even if you don’t make extra payments or round your payments up, you will naturally pay off your car loan faster.
2. Make biweekly payments
Although it may not seem like much, paying twice a month rather than just once will get you to the finish line faster. It will also help save on interest. This is because interest will have less time to accrue before you make a payment — and because you will consistently lower your total loan balance. It helps move you toward an early payoff date without significantly increasing the amount you put toward your loan each month.
3. Round your payments to the nearest hundred
Similarly, rounding up your payments will have a small impact month-to-month but a substantial change overall. By rounding up to the nearest hundred, or at least the nearest whole number, you will slowly reduce the principal of your car loan. You will also get ahead of schedule, which will keep you ahead of interest and ease you into a faster payoff.
4. Opt out of unnecessary add-ons
If you added optional protection like gap insurance, an extended warranty or a service contract to your loan, contact your provider and cancel them. You should receive a prorated refund for the remainder while also lowering your monthly payment. But rather than putting that refund into your pocket, apply it to your loan. This way, you’ll owe less overall and benefit from a lump sum payment.
5. Make a large additional payment
Tax returns, bonuses and other large lumps of cash can go to your car loan. Any time you can reduce your principal by a few hundred dollars, it’s likely worth doing. Like rounding your payments and paying biweekly, it will prevent interest from adding up. As your loan balance decreases, more of your payment will go toward principal, leading to an early payoff.
6. Pay each month
Even if you are ahead of schedule, you should still pay your loan every month. This will keep interest from accruing — which means more goes toward principal, further reducing the interest you pay. And maintaining regular payments when they aren’t required will lead to paying off your car loan early.
When not to pay off your car loan early
Paying off your car loan early means an extra few hundred dollars in your pocket each month. But in some cases, you could negatively impact your finances more than help — so it may not always be the best move.
Avoid paying your loan off early if:
- There is a prepayment penalty. A prepayment penalty essentially punishes you for making extra payments or fully paying off your loan early. It is the lender’s attempt to make up for the interest you would have paid if you had stayed on schedule. If there is a prepayment penalty, make sure it won’t cost you more than you would otherwise pay in interest.
- Your loan uses precomputed interest. Precomputed interest front-loads the interest you pay each year so that the first month accounts for a greater share than the last month. When you pay off your loan early, you won’t significantly lower the cost of your car loan. In this case, it may be better to stick to the loan schedule.
- You don’t have much debt. While it may seem counterintuitive, your credit score is calculated based on the types of debt you have and the length of your accounts. Since car loans are long-term debt, making consistent payments for years will help keep your credit score high.
One caveat: paying off your loan may lower your credit utilization ratio, which accounts for around 30 percent of your credit score. If you have other debts and a high debt-to-income ratio (DTI), then removing one account should help improve your score.
Ways to lower your monthly car payment
Aside from refinancing your loan, there are two ways to lower your monthly payment: defer them or request a loan modification.
Deferment allows you to skip a payment if you are experiencing short-term financial hardship. Lenders may offer one to three months of deferment to help you out. But deferment only moves the payments to the end of your loan, so you will still have to make them up eventually. You will also be responsible for interest, so in the end, it is more expensive.
Lenders may be less willing to modify your loan, but it doesn’t hurt to ask. Much like refinancing, loan modification will change the terms of your loan by either extending your term or lowering your interest rate. If you can get a modification to your loan, you could reduce your monthly payment without having to apply with a new lender.
It may not always be the best decision to pay off your car loan early. If you’d face prepayment penalties or a potential hit to your credit score, the savings won’t be worth it.
But if you want to get out of debt, eliminating car payments is one of the quickest ways to make room in your budget. Refinancing — or just making extra payments — are the best ways to pay off your car loan faster. Even if it’s just a few extra dollars a month, you will reduce your debt and may cut a few months out of your loan.