Paying A Lump Sum Against The Principal
A definitive way to pay off your auto loan quickly is by adding an extra amount to your monthly repayments.
This will help you to lower the outstanding principal, thus lowering the interest you’ll be paying over the term of your loan.
As of March 2020, the average interest rate on a 60-month car loan ranges around 4.42%.
Additional contributions directly to the principal (i.e, the sum you borrowed) are preferable as it helps reduce both the interest and the outstanding total.
For instance, imagine you have a car loan of $20,000 for 60 months at a rate of 7% annually.
Your monthly payment totals $302. The total interest paid is $3,761 over the life of the loan. If you add an extra $100 per month, it will shorten the term by at least 13 months, plus a saving of almost $895 on interest.
We recommend using an online auto loan prepayment calculator to check what you can save.
Is It Worth It?
If you have additional funds and desire to exit from existing debts sooner, making extra payments to lower the principal outstanding is a good move.
Here’s why:
- Huge Savings On Interest - You’re paying the principal, as well as interest and any penalties, and the cost for borrowing as you make your monthly payment on the car loan. When you pay off your principal early, you’ll pay less interest depending on the terms of your loan contract.
- Lesser Risk Of Going Upside Down On The Loan - If you have a long-term loan, the chances of going upside down increases. New vehicles depreciate quickly, hence the resale value goes lower and lower. By the end of the tenure, you’ll owe more than the value of the car.
- Free Up Funds For Other Needs - If you clear an existing loan quickly, you can use the excess funds to meet other needs or pay off other expenses.
Thinking Strategically
Although paying your car loan early may seem like a great way to save money, it isn’t necessarily the right fit for everyone.
Some things that you should take into account are:
- Penalties On Prepayment - Some lenders may charge penalties on the prepayment of auto loans. Make sure to review the loan terms and speak with the lender. In case there is a fee involved, calculate if the benefits are worth it.
- Other Liabilities - If you have other outstanding loans with a higher APR than your auto loan, it’s a better idea to lower those first.
- Credit Score - Monthly repayments play a big role in defining your credit scores. Depending on your credit mix and credit history, you should decide if paying off the loan earlier than the term works in your favor.
- Your Budget - When considering paying your auto loan, it’s necessary to note your other monthly expenses and income. If you already have a tight budget, it’s a good choice to stick to the current plan.
The Final Payment Amount
As you can see, before you agree to pay more for your car payments, a lot of factors like your loan terms, financial requirements, and credit score need to be considered.
You can get a free credit report from Experian to review your credit balance, credit usage ratio, and credit background.
When you get a tip on your score, you can gain a better idea if it's worthwhile to pay additional money on your monthly repayments.
Based on your financial history and total costs, you can choose from bi-monthly payments, weekly payments, and rounding off your monthly payments to the nearest round figure.
Conclusion
In certain cases, when you wish to pay off your car loan early, you may find that your financial situation doesn’t fit.
If you can’t pay early, don't sweat it – other options such as refinancing your car loan can also save you some money.
You can also create or make budget adjustments so that your car loan can be paid off earlier.
