Completely paying off your car loan might seem like a daunting task, but there are some painless ways to get rid of your monthly car payment faster. Paying off your auto loan sooner can be a smart financial move, said Matt DeLorenzo, managing editor of news for Kelley Blue Book’s KBB.com.
“Paying off a car loan early isn’t as crazy as it sounds; people do it all the time with their homes,” said DeLorenzo. But whereas a home might grow in value, a car is a depreciating asset. “So paying the loan off faster if you can afford it not only saves you interest payments — which unlike a home, aren’t tax-deductible — but you also end up owning an asset that is more valuable than it will be at the end of the scheduled loan payments,” DeLorenzo said.
It’s an especially smart strategy in today’s car loan environment, DeLorenzo said, when average loan terms have ballooned to more than 60 months. A longer term increases the amount of interest you’ll pay over the life of your loan. So, if you want to save money and free up hundreds of dollars every month, check out these six ways to pay off your auto loan sooner.
1. Make Bi-Weekly Payments
You might be scratching your head at how paying half of your monthly payment every two weeks could possibly result in paying off your auto loan faster. You’ll find the answer in simple math.
Because there are 52 weeks in a year, when you pay half of the monthly amount every two weeks, you end up making 26 payments. That equals 26 half payments, or 13 full payments — one extra full payment a year. Now, that might not sound like much, but you can do the math to see how that works.
Say you have a 60-month, $24,000 car loan at an annual interest rate of 5 percent. Your monthly payment would be $452.91. But if you can manage to pay $226.46 every two weeks instead of that one monthly payment, you’ll pay off your loan in 55 months. You’d not only save $256 in interest, but you’d have $450 per month — the amount you’d usually put toward your car loan — freed up five months early.
2. Make Sure Your Car Loan Uses Simple Interest
There are generally two ways interest is calculated and charged when it comes to auto loans, according to the Federal Trade Commission: simple interest and pre-computed interest. If you’re going to pay off your car loan early, you’ll likely save more if your loan uses simple interest.
With a simple interest loan, the interest is calculated on the amount you owe. So, the faster you pay off that car loan with simple interest, the less interest you’ll pay.
Pre-computed interest, on the other hand, means that the interest for the life of the loan is calculated up front and added at the start of the contract. With pre-computed interest, if you pay off your loan early, there’s still a chance that you pay the full amount and save nothing, according to the FTC. To be fair, many contracts do include a clause that will refund some of the interest, but you should check before making any extra or different payments with this type of loan.
3. Round Up Your Monthly Payment
Again, you might be surprised at how paying a little extra every month can make a substantial difference in the long run of your loan. The best part is, after you round up your payments for a few months, you might not even notice that you’re paying more — it will just be your new normal.
Here’s an example to see how rounding up works and how much it could save you. If you have that 60-month, $24,000 car loan at an annual interest rate of 5 percent, your monthly payment would be $452.91.
You could skip a night out every month and put that unspent money toward your car loan: Round that monthly loan payment figure up to $500 and you’re paying approximately an extra $48 a month. That’s not totally outlandish — but that extra $48 a month pays your car off six months early and saves you $347 in interest.
4. Put Your Tax Refund Toward Your Car Loan
The average tax refund was $3,120 as of February 2016, the IRS reported. That’s a healthy chunk of money to throw at your loan each year. Sure, there are more exciting ways you could use your tax refund money, but consider the payoff for using your tax refund to pay down your auto loan. Even if you allocated less than half of that refund every year toward your car loan, you’d save yourself significant sums of money.
You can use the same example of the 60-month, $24,000 car loan at 5 percent interest and a monthly payment of $452.91. If you put half of your refund toward an extra car loan payment of $125 each month, you would pay off your auto loan a year and two months early, saving $767 in interest. But more importantly, you’d enjoy over a year without that $450 monthly payment. That’s quite a refund.
5. Refinance to a Shorter-Term Auto Loan
If you have many years to go on your car loan, it might make sense to refinance your loan to a shorter term. A refinancing strategy is best if you can also lower your interest rate with the new terms.
If your credit has improved since you bought your car, you might qualify for a lower rate. For instance, according to Interest.com, those with poor credit — scores of 600 and lower — are charged interest rates that are three to four times higher than those with good credit, averaging a whopping 11.03 percent in the first quarter of 2016. If your score has improved since you bought your car, you could dramatically lower your rate and monthly payments. That could help pay off your car sooner and save you a lot of money.
Here are a few tips about refinancing to consider:
- You can use an auto loan calculator to determine if refinancing might be a good fit for you; there are several available online.
- Check your credit score to get a better idea of what kind of rates you would qualify for.
- Verify that your current auto loan doesn’t penalize you for early payoff. If it does, weigh the cost against how much you stand to gain through refinancing.
6. Make Extra Car Loan Payments
There’s no set rule that says extra payments have to be uniform or regular. So when it comes to making extra payments toward your car loan, you can apply the same strategy that most people use when it comes to flossing their teeth: Do it randomly and only when the spirit moves you.
With this method, you’d pay a little extra whenever you have a little extra to spare. You can use the same example of the 60-month, $24,000 car loan at 5 percent interest with a monthly payment of $452.91.
This time, for example, you could skip your daily latte every once in a while and increase your car payment with the savings, paying an average of an extra $50 every other month. You’d still pay off your car three months sooner and save $191. Flossing never felt so good.