4 Proven Ways to Pay Off Your Car Loan Faster

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Your monthly car payment doesn’t have to hold you back.

Pretty much everyone these days has a car loan. If you glance around your company parking lot or notice the cars you pass on the street, chances are you’re looking at vehicles that have yet to be paid off.

According to research from Experian, about 55% of used cars are financed and 85% of new vehicles have a loan on them. Experian also found that outstanding auto loan debt rose by 6.5% in 2019 compared to the first quarter of 2018.

If you’re currently paying off a car loan, here’s how you can do it faster — and how that can save you money in surprising ways.

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Why You Should Pay Off Your Car Loan Faster

For most people, a car loan is a way of life. It’s not until the loan is paid off that you realize how much better it is to be debt-free.

Instead of paying for the right to drive your car, you can finally feel like you own it. Instead of fretting every time you make a purchase or review your budget, you can focus on enjoying life and saving for the things you really care about.

But there are several other reasons to focus on an early payoff for that auto loan.

Save Money on Interest

The most common reason to pay off any loan faster is to save on interest. At the end of 2019, the average interest rate on an auto loan was 6.11%, and the rate can be much higher for borrowers with poor credit scores.

A 60-month auto loan at 6.11% interest on a $20,000 car will cost $3,261 in total interest. All other factors remaining the same, a $35,000 car will rack up a whopping $9,890 in interest.

Example A

Loan amount: $20,000
Loan term: 60 months
Interest rate: 6.11%
Estimated monthly payment: $388
Total interest paid over life of loan: $3,261

Example B
Loan amount: $35,000
Loan term: 60 months
Interest rate: 6.11%
Estimated monthly payment: $678
Total interest paid over life of loan: $5,706

The takeaway here is clear — the faster you can pay off an auto loan, the more money you’ll save.

Even if you’ve managed to secure a relatively low interest rate, being in debt can be like walking around with a weight on your back. It’s always there in the back of your mind, dragging you down and darkening your outlook on life. The sooner you become debt-free, the sooner that burden is lifted.

Pay Less for Insurance

There’s also the matter of insurance costs. Borrowers who finance a vehicle are often required to buy more insurance coverage as part of the loan terms. Specifically, they have to buy full coverage which includes comprehensive and collision.

You may even be required to have a lower deductible (For example, $500 instead of $1,000), making your premiums even more expensive. Once the car is paid off, you can choose whatever level of insurance coverage you want.

Borrowers who pay off a car can switch to liability only insurance can save hundreds each year. The average annual cost of comprehensive and collision coverage insurance is $1,427 a year while the minimum is only $606. This represents a $821 difference.

Easier to Sell a Car

Selling a car with a loan on it can be very tricky. In a private sale, you often have to complete the sale at the lender’s office so the buyer can pay the lender directly. This might not be a problem if you’re selling to a close friend or family member, but selling a financed car on Craigslist is a lot harder.

In many cases, a borrower may find that they owe more than the car is worth. This is also known as being upside down, or underwater, on a loan. If this happens, it may be impossible to sell the car unless you can pay off the difference with money from savings.

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Even getting into a car accident when you have an auto loan can lead to extra headaches, according to finance educator Bola Sokunbi of Clever Girl Finance.

The insurance company may only pay out the value of the car and not what you owe on it. If the value is less than the remaining balance, you’ll be responsible for that portion (unless you have a GAP waiver).

Even if the accident wasn’t your fault, you may still be responsible for the difference if you live in a no-fault state.

Increases Chance for Mortgage Approval

A car loan can even complicate the mortgage approval process. Mortgage lenders look at your debt-to-income ratio, which is your income divided by your monthly debt payments. A bank usually wants a DTI less than 36%, which includes your current loans and future mortgage payment.

An auto loan balance may put you over that 36% limit, making it hard to qualify for a mortgage and even harder to secure a low interest rate. If you pay off the car loan, you’ll have a lower DTI and a stronger case for approval.

What to Know About Paying Off Your Car Loan Early

Paying off a car loan early can be harder than it sounds. Lenders may charge a prepayment penalty, which is a fee for paying off the loan ahead of time. This fee varies for each specific loan and is set by the lender. In some cases, the prepayment penalty may be the total interest remaining on the loan.

There’s no way to get rid of the prepayment penalty once the loan is in effect — it’s part of your contract. Even if you refinance the car, you’ll still have to pay the prepayment penalty. This is why it’s important to make sure your lender doesn’t charge you a prepayment penalty when you sign up for the auto loan. You’ll typically see this in subprime auto loans.

How to Pay Off Your Car Loan Faster

There are plenty of good reasons to pay off your car loan faster — here’s how to actually do it.

Option 1: Refinance 

Refinancing is when you switch loan providers to get a lower interest rate or lower monthly payment. If you want to pay off your car loan early and save on interest, consider refinancing to get the lowest interest rate.

Here’s how it may work. If you have a $20,000 loan with a 6.11% rate and 60-month term and refinance to a 4% rate with the same term, you’ll save almost $1,161 in interest.

Example A
Loan amount: $20,000
Loan term: 60 months
Interest rate: 6.11%
Estimated monthly payment: $388
Total interest paid over life of loan: $3,261
After Refinancing: Same Loan Term
Loan amount: $20,000
Loan term: 60 months
Interest rate: 4%
Estimated monthly payment: $368
Total interest paid over life of loan: $2,100

But many people also choose to get a shorter term when refinancing, and a shorter loan term which often comes with even better rates.

After Refinancing: Shorter Loan Term
Loan amount: $20,000
Loan term: 48 months
Interest rate: 2.99%
Estimated monthly payment: $443
Total interest paid over life of loan: $1,245

That’s $2,016 in savings by refinancing your current auto loan.

When refinancing, you can sometimes end up with a lower payment on a longer term. This longer duration may actually result in a higher interest burden over the lifetime of the loan and puts you at risk for being upside down. If this is the case, you should keep making the same payments as you were before. You’ll pay off the loan faster and pay less interest overall.

The best way to do this is by setting up automatic payments from your checking account to the car loan. This way, you’re never tempted to pay the minimum — and you’ll never miss a single payment.

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Option 2: Pay Every Two Weeks

Sokunbi says one of the strategies she recommends is paying your auto loan every two weeks instead of once a month. You can do this by dividing your total auto loan payment by half and paying half of it every two weeks.

“I don’t think this is something people realize they can do,” Sokunbi said. “They can reach out to the loan provider and ask to be put on a biweekly schedule.”

When you use this strategy, you end up making one extra payment a year. But because the biweekly payments are tied to your paycheck, it doesn’t feel as painful. Some lenders will set this up for you and send you a bill every two weeks, or you can do it yourself.

A borrower with a $20,000 60-month loan at 6.11% interest would save $328.59 total by making biweekly payments and pay off the loan five months early.

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Increasing your monthly payment by $0 will save you $0 in interest and you will pay off your loan 0 months sooner!

Option 3: Add Windfalls to the Loan

Every once in a while, unexpected money falls into your lap. This may come as a tax refund, a bonus from work or a rebate from an item you purchased.

When you get a windfall, put the extra cash toward the principal balance of the car loan. You can either put the entire lump sum toward the loan or divide it between other goals, like a vacation or home remodel. If you feel like splurging, put 90% towards your debt and use the remaining 10% to go shopping or treat yourself to a nice dinner.

Windfalls are great because they’re often a surprise, so they feel like bonus money. If you put a windfall immediately toward the auto loan, you won’t have time to ponder how else you could spend the extra money.

If you’re paying extra on your auto loan, make sure the funds are going toward the principal and not just interest or other fees. You may have to call the lender directly and ask them to apply the funds this way. If you pay via check, you should write “principal” on the memo portion.

Option 4: Cut Expenses

Even after refinancing and using windfalls, the best way to pay off your car loan early is to cut money from your budget and add it to the loan. This may include limiting take-out meals, signing up for a cheaper cell phone plan, or cutting back on subscription services.

If you don’t currently have a budget, consider making one to gain a firmer grasp on your finances. It’s easy to let money slip between the cracks when you’re not keeping track, but monitoring expenses will give you a whole new appreciation for where your money is going.

Which Debt Payoff Method Should I Use?

If an auto loan is the only kind of debt you have, your repayment strategy should be fairly simple. Put as much money as possible towards your loan each month, making sure to never miss a payment and always pay in full.

If you’re trying to pay off multiple forms of debt, things get a little more complicated. There are two strategies recommended by most financial experts: the snowball method and the avalanche method. Both of these methods refer to the order in which you prioritize your debts.

The avalanche method involves prioritizing the debt with the highest interest rate. This strategy will save you the most on interest, but it can take longer to knock out individual debts.

The snowball method, as popularized by radio personality Dave Ramsey, says you should prioritize debt starting with the smallest total balance. Once each debt is paid off, you can add that monthly payment to the next smallest balance.

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A 2012 study from Northwestern University’s Kellogg School of Management found that people who used the snowball method are more likely to pay off their debt. Participants felt more successful when they paid off individual loans, and these small wins propelled them to keep going.

Picking your strategy is largely a personality decision. If you’re the type of person who feels discouraged by your debt, then choose the snowball method. If you’re more focused on long-term planning and not overly concerned with your current debt situation, the avalanche method is probably your best bet.

Make a list of all the debt you have, including the auto loan. Note the interest rate, total balance and minimum monthly payment. Depending on your other loans, the auto loan will have the lowest balance, the highest interest rate or fall somewhere in the middle.

If you want to utilize the snowball method, order the list from smallest balance to largest and focus on paying off the smallest balance. Those using the avalanche method should arrange the list from highest interest to lowest.

Using either of these strategies could mean that your auto loan becomes a lower priority. If paying off the car is your number one concern, you can always focus on that and come back to the other loans later.

Paying Off Debt is a Holistic Decision

Paying off your car loan early isn’t just a financial or mathematical decision. It’s also an emotional one. Debt can cause anxiety and stress, and unloading your car loan can ease your mind. Once you pay off the car loan, you can put the money toward an emergency fund, retirement savings or child’s college education.

You can also put the same amount of money in a savings account to buy your next car in cash and skip the loan completely. This also gives you more leverage at a dealership because you can pay for a car in cash.

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About The Author

Zina Kumok

Zina Kumok is a freelance writer specializing in personal finance. She paid off $28,000 worth of student loans in three years. She's written for Investopedia, Business Insider, and Forbes. She also offers financial coaching at ConsciousCoins.com.

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