My son recently bought a car of his own so he can use it when he goes to Rutgers University. The journey began earlier in the summer when he starts hunting for his perfect car. But I brought him down to earth by explaining the process especially applying for an auto loan.
So he started applying for a pre-approval loan through several banks and he was rejected because of his lack of credit history. One bank approved a loan under pre-condition with high interest rate. He was shocked of how difficult it was to buy a car.
I stepped in and helped him to get the loan from the car manufacturer using co-signing. We were able to get the loan with low interest rate. We were quite happy with the loan condition because of low monthly payment and there is no penalty for paying off early. The car dealership finance manager asked if we plan to pay the loan off early. That is a very good question of which I’ve thought of when I had two car loans prior to this.
There are pros and cons when it comes to paying off loan early. The obvious pro is that you get to be debt free early. This is especially true for someone who hates to carry a debt. But that does not mean that you will be totally debt free because everyone carries other debts (i.e. mortgages, credit cards etc.). Another benefit of paying off the car early is that you get to own the car early and you are not required to have a comprehensive full insurance coverage, which is an added saving.
Let’s address the elephant in the room. The car payment is big chunk of anyone’s budget. Besides our daily obligations such as grocery bill and fixed cost, car payments can be a big portion ofour our monthly expenses because of the condition of the loan. Unlike a mortgage which could be 15 to 30 years loan, auto loan is usually 5 or 6 years loan. That means that monthly payment could be high depending on how much you are borrowing.
You can opt to pay more every month so you can pay off the loan early. A mortgage will reduce its monthly payment when you pay more upfront. BuyAuto loan is fixed every month regardless how much you pay more. The only benefit is that it will reduce the period of repayment by several months. So paying more every month will not likely to make a dent on your monthly obligations.
Before going through this point, everyone should ask the question why would they need to have a new car on their driveways. Cars today rarely break down. The quality of the cars have improved dramatically that most will last 10 years before breaking down. Are you ready to absorb another cost when the benefits of owning a car rarely outweighs the costs?
If you can afford to pay for the car then the answer to paying off early makes sense. It is highly recommended that you make a proper budget to ensure you can afford the car payment. Once you are aware that you can afford an extra payment, paying more on the principal will help. However, as I alluded to above it will hardly make a difference in the long run unless you pay extra every month.
My son was able to get a good rate on the car loan. After paying off the loan in 72 months, it will only cost him $1,500 for the entire loan. If he pays off the loan early, it may lower the cost by a few hundred of dollars. However, he could repurpose the money for something more beneficial. For example, if he invest the $7,200 (assuming that he pays $300 every month for the next 2 years) with an average monthly return of 12%, he would have made a profit of about $2,000 by the end of second year. Obviously this is being optimistic but history shows that it is possible to obtain 10% return annually based on conservative stocks. Keeping the money in investment will continue to grow year on year.
However, if you have a high interest auto loan then it may makes sense to pay off the loan early. This should only be done if you can actually afford to forgo the money otherwise that you can use it for something else. Another option to minimize the cost of the loan is by taking a personal loan from a bank with lower interest rates.
Everyone’s financial situation is different. Paying off the auto loan early may make sense if you have a large outstanding debt or if you have the means to do so. It is important to consider if paying off would benefit in the long run. The best way to manage any auto loan is simply not to have it. If you can continue to use your existing car for a few more years there is no reason to obtain a shiny new car with a large price tag.