Prior to moving to the United States I had never owned a car or had debt before. Subsequently, the only thing I knew about car loans was bits and pieces I picked up from family and friends. Nevertheless, when I finally decided to purchase my car, I knew an auto loan made the most sense if I didn’t want a jalopy.
The cost of my car was just shy of $10,000. To date, I have paid off 42% of the original cost of the car and I am half a year ahead on my auto loan repayment due date. I plan to have the remaining balance repaid by next year.
This article explains how I did this and how you can too. Note that because I have no intention of carrying the loan for the full term, I pay attention to my to-date repayment balance as shown by Capital One, not the repayment balance for dragging it out full-term.
1. Pick the Right Car
Whether you’re a college student or a working adult, it’s tempting to splurge on your dream car or its closest substitute. However, more often than not, these cars are either more expensive or not the best quality when it comes to long-term maintenance costs. I picked a car that met the following standards:
- Relatively inexpensive
- Relatively low mileage on the dash (42,702 miles)
- One of the most reliable models on the market
- Received a clean bill of health from a mechanic
- Attracted low insurance rates
- Great MPG
Want more details on what to look for in a new car? Check out this post in The New Driver Series that is dedicated to the topic:
2. Set a Monthly Budget
In the article referenced above, I spoke about the importance of keeping your loan term at five years or below. Dealerships and lenders will pitch longer terms to lower your monthly payments. However, this comes at the cost of higher interest rates and potentially owing them more money on your car than it’s worth. Naturally, you also won’t be paying off 42% of your car in a year.
Focus on the monthly cost for a five-year term or less. That should be the marker for deciding what’s affordable. As I also mentioned in the previous article, when deciding your monthly budget, remember to factor in the cost of maintenance, gas, and insurance. The more you stay below your budget, the more money you have to make extra payments. More on that later.
3. Get a Good Interest Rate
Don’t settle for the first interest rate offer you get. Shop around to see who might get you the best deal. However, to avoid ruining your credit, avoid hard checks until you have settled on a car and you’re ready to buy.
You want to keep all your hard checks over a two-week period or so to ensure the credit bureaus count it as one. This also helps you to avoid purchasing after your credit score begins to dip. Remember credit unions are usually the best options for getting low-interest rates.
That said, you do have some control over your interest rates. Lenders may consider the following factors when deciding on an interest rate:
- New or used vehicle
- Personal credit history
- Individual or household income
- Year, model or make of the vehicle
- Down payment versus amount borrowed
4. Use a Sizeable Down Payment
As alluded to above, when you finally choose the car you plan to purchase, you may need to make a down payment before securing the loan. If you have excellent credit or the dealership is running a promotional offer at the moment, you may not need to make a down payment.
Even if you don’t need one or the minimum is low, make as big a down payment as you can without stretching your finances too thin. Even though I was initially not sure that I would ever purchase a car, I had set aside my tax refunds since migrating for that purpose. I used this to cover my down payment and six months of insurance.
5. Check for Early Repayment Fees
Ideally, a lender prefers that you hold on to the loan for the full term and make only your minimum and mandatory payments every month. Early repayment benefits consumers, but it does not necessarily benefit a bank. It does allow the bank to reclaim its loaned capital, but it loses out on the interest it planned to receive over the next half a decade or so.
Because of this, some lenders use penalties to discourage the practice. Check with your lender to see if there are fees for repaying your loan early. If there is a fee, this does not mean you shouldn’t aim for an early pay-off. If you save enough in interest to account for the fee or paying off this loan could offer better qualification opportunities for another loan—such as a home loan—it may still be worth it.
6. Make a Few Bulk Payments
At this point, you may be surprised, and perhaps annoyed, that I have yet to get to what to do after you purchase the vehicle. That’s because an early-payoff takes preparation. However, even if you didn’t pick the most affordable car, or you skimped on the down payment and took a long loan term, there is still hope.
You can make a few bulk payments to lower the principal balance. Be sure to check with your bank to ensure these payments go directly to the principal and not the interest owed. You can think of these as belated down payments.
7. Round Up Monthly Payments
I had other expensive uses for my money this year, so I only had a few opportunities to make larger-than-requested down payments. I do, however, round up my payments every month. My exact monthly premium is $153.64. I pay $160 instead and put the extra money toward the principal, not interest.
It may not seem like much, but over time, this adds up. Over a five-year period, that’s $381.60. This is roughly two and a half monthly payments. After October, I plan to round up to $200 instead.
8. Stay One Payment Ahead
All of these things combine to explain why I am half a year ahead on my car payments. If this is not a feasible goal for you at present, at least stay one payment ahead. It only takes one missed payment to begin the downhill spiral of your payment history and credit score. Don’t risk it.
When you stay one payment ahead, then you can pay your car note on any day of the month that is most convenient for you. If your check is late or you change jobs, you can rest easy.
However, do not assume that if you pay a lump sum of payments upfront that you will not need to pay the next month. Some lenders will still want next month’s payment. Check with your lender to see what your options are.
9. Pay As Early as Possible
Note that most car loans operate on simple interest. These types of loans accrue interest on a daily basis, so the earlier you make your payments, the better. Don’t use staying one payment ahead as an excuse to procrastinate.
For example, Capital One tells you what your payoff date is today versus ten days from now. There is an $8.72 difference for me. This may not initially seem like much. However, if you consistently pay ten days later every month, that could easily add up to around $318.28 or more in additional interest over a 12-month period.
10. Lower Your Insurance Premium
Car insurance will be one of the most expensive costs of car ownership. If you finance your car and/or your license is new, there are instances where your car insurance is even higher than your monthly car note. This was the case for me until recently. Thankfully, you can lower your auto insurance over time. Find in-depth advice on how to do that here:
Why is this so important and what does it have to do with paying off your loan early? The less money you pay on insurance, the more disposable income you have available to repay your loan early. Even shaving just $50 off your monthly premium could result in an extra $600 on your car loan for the year. Over a five-year period, that’s $3,000!
In the final New Driver Series installment, I’ll do a review of my car. I write car reviews for clients all the time, so it will be interesting to tackle one for a car I’ve actually owned for more than a year so far. I get a lot of questions from parents and new drivers about how well it holds up as a first car and I strongly recommend it.
Update October 12th 2019: The car is now 65% paid off and is 2 years and 3 months ahead of its original payoff date.
Update July 10th 2020: I paid off my car in June (less than two years after purchasing it) and traded it in for an FJ Cruiser this month. I am now debt-free and paid only $570.77 in interest.