How much do you spend on your auto loan payment every month? The average American with a car loan spends $495 for a new vehicle, and $362 for a used vehicle, Experian’s recent State of the Automotive Finance Market report found.
With monthly payments like that, it’s no wonder you’d want to get that monkey off your back and pay off your auto loan as fast as possible. But is that really the best decision in your situation? Here’s a guide to help you assess your situation and financial priorities to determine whether paying off your auto loan before other debts is your best course.
How do auto loans compare with other types of debt?
Luckily, auto loans are one of the cheaper forms of debt. The average interest rate in 2016 for a 60-month new car loan was 4.14%, compared with 4.41% for a 30-year mortgage in 2017 and credit cards at about 14%. Student loans are cheaper yet, at a 3.76% for direct subsidized loans in 2017.
Just because auto loans are a cheaper form of debt doesn’t mean it’s any easier having them, though, so it makes sense why you want to pay them off. Let’s look at the pros and cons of paying off your auto loan early.
What are the benefits of paying just the minimum amount due?
There are two reasons that you’d want to hang on to your loan. The most important one is you may be able to maximize your dollars by placing them elsewhere rather than paying off your auto loan.
To see how this works, let’s say you have an extra $200 to pay toward your debts each month. The name of the game here is to compare interest rates. Find the interest rate on your auto loan as well as any other sources of debt you have, such as credit cards, student loans, mortgage or personal loans. If you have other sources of debt with higher interest rates than your auto loan, it’s best to focus on paying off those ones instead, because those are the ones that are the most expensive.
On the flip side, some people suggest investing your money instead. You can earn an average return of about 7% by investing in the stock market, and if the interest rate on your loan is lower than this, you’ll come out ahead in the long run. Of course, the stock market can decline or earn less than 7%, but in the long run you are more likely than not to have slightly more money in your pocket by investing it instead.
A very minor advantage of paying the minimum amount on your auto loan is that you’ll retain a small boost in your credit for a longer period of time. Your auto loan will stay on your credit report for up to 10 years after you pay it off, so by paying just the minimums, you can take advantage of this small credit boost for longer.
The key word here is minor, though — this factor only contributes 10% to your final credit score, meaning 90% comes from other good activities such as paying your bills on time and not racking up huge amounts of credit card debt. Keeping your auto loan for longer will cost you more money and the small boost you get probably isn’t worth the cost. You can boost it more (for free) by focusing on other areas instead.
What are the benefits of paying off my auto loan early?
The biggest advantage of paying off your loan early is that you won’t have a monthly payment anymore. Each monthly payment is a liability, and if you lose your job or are otherwise unable to make your payments, you can wreck your credit score very quickly.
You’ll also save a lot of money in interest payments. You can actually find out how much you’ll save by finding an auto loan payoff calculator online. All you have to do is plug in the details of your loan — interest rate, loan term (length), and loan amount — as well as how much extra you can pay toward your debt each month. The calculator will show you exactly how much money you can save.
Finally, it might provide a psychological benefit to you to pay it off early. This isn’t too be taken lightly; knowing that you’re free of debt (or at least a debt) can be a serious stress-reliever. If you’re debt-averse, then being free of this debt can ease your burden and make you a healthier, happier person.
Should I pay off your auto loan faster, then?
In this case, it’s a personal decision that only you can make for your situation. If the idea of being in debt makes you sweaty and keeps you up at night, paying it off can allow you to get a good night’s rest.
From a financial standpoint, it can be a good idea to keep the debt only if you use that extra payoff money for something that will bring more dollars to your pocket in the long game — i.e., by paying off higher-interest debt first, or by investing it in the stock market if you’re comfortable with that.
Whatever option you choose — pay off your auto loan or reserve those funds for better things — will be a good decision, it’s just a matter of which one is the best decision for you. As long as you don’t blow that extra debt payoff money on frivolous expenses, you’ll come out with a stronger financial position in the end.
One way that you can minimize your auto loan costs is by shopping around. You can easily compare auto loan rates from dozens of companies with SuperMoney. You can also qualify for the best rates by boosting your credit score.
Lindsay is a recent college graduate living in Fort Collins, CO. She taught herself how to manage her money after a series of bad encounters with student loans, low-paying jobs, and a house from hell. Today, she’s working hard to pay off her debts, earn more money, and find her dream job as a wildlife biologist. You can find her work on many financial sites like Magnify Money, Credit Sesame, and Centsai.