Steps To Paying Off A Car Loan Early

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, - May 27, 2016

A car loan is a great way to purchase a new or used vehicle when you don’t have the necessary cash on hand, but the car loan rate you receive might not be the most favorable. If this is the case, putting yourself in the position to pay off the car loan early ultimately means fewer payments for you and less interest paid to the lender. In order to do this, you will take the necessary steps. The way a car loan is structured, you borrow a principal amount, receive an interest rate and have a certain amount of time to pay the loan back. The time in which you have to pay it back is known as the loan amortization period. Paying off your loan before that period expires may be possible. Consider these three steps to help you pay off the car loan early.

Budget

The first step is to look at your budget. Your budget should be the first step in any important financial decision, and importantly in this one. If you do not have a budget, make one. Place all sources of income and plan out your fixed and variable expenses. This will help you get a good idea of how much money you may be able to spend on a car.

Rule of Thumb

One easy way to figure out what you can afford is by using your income. Based on your monthly net income, experts recommend that you should not pay more than 20% of this figure, which includes the combined principal payment and interest payment.

Don't forget to include other expenses, though. A rule of thumb is to multiply what you can afford by .66. Operating expenses can be anywhere from one third to one half of the monthly cost of a new car.

Make Bigger Car Loan Payments

Once you have an idea regarding what you can afford, you need to consider payments. Car loan payments will be determined based on the interest rate you get for the loan and for the duration of the loan. A typical car can be purchased over three to five years, for instance. Car loan rates will vary depending on the institution and your credit record.

If you can afford it each month, the best way to pay off your car loan early is to double your monthly car loan payments. It does not have to be double, but anything more will help. Loans are structured so that you pay off the interest over the first part of the loan and only then start to make a dent in the principal. If you pay double each month, you cut down on the interest twice as fast and start paying on the principal much sooner. Doing this, a five-year loan could very well turn into a two to three year loan. By paying more each month you will be spending more in the short term but saving more in the long term. Lowering the amount of principal to be paid back reduces the amount of interest you will pay.

It is possible to pay back your car loan before the loan period expires. Doing so will save you a lot of money that you would otherwise pay in interest charges. Check with the terms of your loan to see if you will be penalized for paying it back early. If not, consider paying one-in-a-half to twice the payment each month.

Deciding on affording a car loan is a very important decision which should not be taken lightly. In order to make a sound financial decision, you need to assess your financial situation and the payments of the car loan. Follow these tips in order to see if you can afford a car loan.

Borrow Less Money

If you know that you want to pay the loan back early but still need it to buy your car, consider borrowing less money. It is a simple equation–less money borrowed means less to pay back. It might mean that you have to buy a less expensive car, but if you are concerned about the total interest you will pay, chances are you aren’t the kind of person who needs the world’s flashiest, most expensive car.

Check the Terms of Your Loan

The fine print on some car loans indicates that you will be charged a fee if you pay off your loan early. This is to say that the lender will penalize you for taking the initiative, paying off the car loan early and thereby depriving them of interest payments. It is unfortunate, but profit realized from interest payments is the only reason car loans are given out at all. Lenders protect their own financial interest in the contract by including such terms in the contract. If you have not yet signed the car loan agreement and know you want to pay off the loan early, negotiate with the lender to have this clause stricken from the contract. If they won’t agree, go elsewhere.

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The CarsDirect editorial team is dedicated to providing our readers with the latest on new and used cars, expert opinions on which vehicles make the grade, and all the fun stuff in between.


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