How to Make Extra Payments Toward a Car Loanby John Csiszar
When you finance a car and agree a loan that requires several years of monthly payments, the last thing you probably want to do is send your lender more money than you have to. However, making extra payments toward a car loan often can be a financially smart move. With a careful look at your budget, you might be able to find easy ways to make extra payments. This payment strategy might also help get your car loan paid off faster.
The easiest way to make extra payments without disrupting your monthly budget is to allocate any extra income you receive to your car loan. For example, if you get a year-end bonus from your employer, put that money toward your car rather than simply spending it. If you examine your yearly cash flow, you're likely to turn up numerous sources of extra or unexpected income you can put toward your car, such as birthday gifts, purchase rebates, contest winnings or tax refunds.
One strategy to help you make extra payments is to pay half your monthly payment every two weeks, rather than once per month. Since there are 52 weeks in the year, paying bi-weekly means you'll end up making 26 half-payments per year. Essentially, you'll end up making 13 monthly payments per year instead of 12, shaving about six months off a typical five-year car loan.
An easy way to put extra money toward your car loan is to round up your monthly payment. For example, if your regular monthly payment is $371, round that amount up to $380, or even $400 if you can. That small amount is not likely to make a huge dent in your monthly budget, but it can pay big dividends when extended out over the course of a five-year car loan.
Most car loans are structured using simple interest, meaning interest is calculated and added every day based on your then-current balance. The faster you can pay off your car loan, the more interest you'll save. For example, if you have a five-year car loan with a starting balance of $15,000 and an interest rate of three percent, you'll pay about $1,171 in total interest over the life of the loan. If you make regular extra payments and pay that loan off in just four years, you'll only pay about $936 in interest, a savings of about 20 percent. Some financial experts, such as Suze Orman, recommend paying off a car loan in three years or less.
Any extra money you put toward a car payment carries an opportunity cost: if you send the money to your car loan, you can't use it for anything else. It might not make sense to make an extra car payment if it means you won't have available money for emergencies, for example. Money you put toward a car payment also generates no tax benefits, as a contribution to a 401(k) plan or other retirement savings might. If your car loan carries an exceptionally low interest rate, paying it off sooner might not be the best financial move for you if you can generate higher returns on that money elsewhere, such as in a bank account or other investment. Some loans may actually penalize you for making additional payments, or even prohibit them outright.
Whether or not making an extra car payment makes sense depends on your personal financial situation. While getting out of debt as soon as possible generally is beneficial, you'll have to incorporate all of your financial variables to determine the best allocation of your resources.