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The Key to Saving on Car Loan Interest: Treat It Like a Mortgage
About a year and a half into my five-year car loan, I decided to do whatever I could to pay it off.
I, like many, rely on my car to get me to and from work every day, and to ferry my toddler to daycare and various playdates. My former — paid off — Mazda2 wasn’t cutting it size-wise, so I made the decision to upgrade to a new Subaru Outback, which had plenty of room for my family.
Unfortunately, buying my car meant I now faced a somewhat painful monthly payment on top of all my other bills, like mortgage, food and utilities.
I started looking into how I could pay off my loan and was immediately surrounded by intimidating lingo about interest rates, loan terms and additional payments. So I did what every Penny Hoarder would do — I researched the best ways to achieve my goal and set off on my loan-ending mission.
Understanding Car Loan Interest Rates
You want to pay off your car loan ASAP to avoid paying extra interest. Depending on where you source your loan and your credit score, your interest rate can be anywhere between 2% and 25%, according to Nerdwallet. Bankrate’s interest rate tool shows the average consumer paid around 5% in interest in February 2018.
You also need to understand the type of interest you’re paying on your loan.
With a car loan, the lender will likely charge you simple interest, which is calculated solely on the principal balance of the loan.
Some lenders, however, charge something called precomputed interest. To determine how much you’ll pay, your lender will take the original term of your loan — say, 48 or 60 months — and use it to calculate how much you’ll pay total.
With precomputed interest, you cannot make extra payments to just the principal balance, so you end up paying the same amount whether you pay off your loan early or not.
If you’re stuck with a loan that charges precomputed interest, see if you can refinance with a lender that charges simple interest instead. Banks and credit unions are more likely to use simple interest.
When shopping for a car loan, make sure you ask how the lender calculates interest and stick to simple interest whenever possible.
Treat Your Car Loan Like a Mortgage
Many experts recommend adding a 13th payment each year to pay down your mortgage faster. Let’s apply that same thinking to knock out your car loan.
According to Payoff, you could pay off a 60-month loan for $10,000 in just 49 months by making an extra $500 payment each year. That would save $468.88 in interest over the life of the loan.
But scrounging up an extra $500 a year is easier said than done. Gina Horkey with the Huffington Post recommends nabbing that 13th payment by asking your lender if you can split monthly payments into biweekly payments.
This especially makes sense if you’re paid every other week. Spreading your payments out this way means you’ll end up making 26 payments, which is the equivalent of 13 full payments in a year.
Pay Extra When You Can
My monthly car payment was $325, but I had budgeted $350 before I began shopping for my car. So, rather than paying the minimum each month toward my loan, I paid the full $350.
With just that extra $25 each month, I paid an extra $300 per year on my loan. If I had just done this for the life of the loan and nothing else, I would have paid it off four months earlier and saved $108.77 in interest, according to Bankrate’s car loan payoff calculator.
Use Your Skills
Need some extra moola to help pay down your crazy car loan? Consider your skills and see if you can find a side gig to help you earn more.
For me, that skill was writing. I earned extra money on the side with freelance writing, which helped whittle my loan balance down to an amount I was comfortable paying off from my savings.
Maybe you’re good at math and can tutor on the side, or perhaps you love dogs or kids and can spend some time dog sitting or babysitting to earn extra cash. You can even put that car to work driving for Uber and getting five stars for that authentic new-car smell.
Whatever your skill, make sure the money you earn goes directly to your car loan.
Consider opening a separate bank account to directly deposit your side-gig money into, then empty the account toward your car loan each month.
No matter what you do to pay off your car loan early, you’ll love the feeling of making that final payment and knowing that your paycheck will be that much bigger in future months.
Catherine Hiles is a writer and editor living car-loan-free in Ohio. She plans to keep her ride as long as possible to avoid adding another loan to her monthly expenses.