Paying extra on a car loan usually applies the funds to the principal, helping you pay it off faster, save significantly on total interest (especially early in the loan), and build equity quicker, but you must check for prepayment penalties or specific lender instructions to ensure money goes to principal, not future payments, and consider if your high-interest debt or emergency fund needs priority first.
Extra payments can help you build equity, save on interest and pay off your auto loan faster. Make sure you allocate extra payments in a way that saves you the most money.
You'll save money.
Unless your loan has precomputed interest (more on that below), extra principal payments can help reduce the total amount of interest you'll pay.
How to pay off your car loan faster
Extra payments made on your car loan usually go toward the principal balance, but you'll want to make sure. Some lenders might instead apply the extra money to future payments, including the interest, which is not what you want.
Dave Ramsey's core car rules emphasize paying cash, avoiding new cars (unless you're a millionaire), keeping your total vehicle value under half your annual income, and using a strict budget, often suggesting the 20/4/10 rule (20% down, 4-year loan, 10% total car expenses) as a guideline if financing, but preferring no debt at all to avoid depreciating assets trapping you. He stresses buying reliable, used vehicles to prevent debt and build wealth.
The 50/30/20 rule is a simple budget guideline: 50% of your after-tax income for needs (like housing, groceries, and car payments/expenses), 30% for wants (dining out, entertainment), and 20% for savings and debt repayment. For a car payment, this means your total monthly car expenses (loan, insurance, gas, maintenance) should ideally fit within the 50% "Needs" category, with some experts suggesting car costs shouldn't exceed 10-15% of your income overall, making a modest car a "need" and luxury vehicles a "want".
THE PROS: WHY EARLY PAYOFF MIGHT BE A GOOD CHOICE
The longer you take to pay off your car, the more you'll pay in interest. Paying it off early can reduce the total cost of the loan, especially if you got a higher interest rate when you bought the car.
To be clear, extra car payments may not automatically go to the loan principal. They'll most likely be applied to interest first unless you specify how to apply them with your lender.
Overpay your car finance
Surprisingly, making extra payments towards your car finance can work wonders. These additional payments directly tackle your loan's principal, leading to a faster loan payoff and reduced interest costs.
There are several ways to pay off your loan — like refinancing, paying biweekly or rounding up your payments to the nearest $100. Confirm your lender doesn't charge a prepayment penalty since the cost of an early payoff could be more than what you save.
Biweekly payments
By the end of each year you would have paid the equivalent of one extra monthly payment. This additional amount accelerates your loan payoff by going directly against your loan's principal. The effect can save you thousands of dollars in interest and take years off of your auto loan.
Input a monthly payment amount
Take-home pay is the amount you make each month after taxes, so if you bring home $3,000 monthly after taxes are deducted, it's likely you can comfortably afford a $300 car payment.
With a $50k salary, you can likely afford a car in the $20,000 to $35,000 range, aiming for monthly payments under $300-$400 (10-15% of your take-home pay) after a 10-20% down payment, and considering reliable models like Hyundai Elantra, Kia Rio, or Honda/Toyota used cars to keep costs low, factoring in insurance, gas, and maintenance.
To pay off a 5-year car loan in 3 years, consistently make extra principal payments through strategies like bi-weekly payments, rounding up payments, applying windfalls (bonuses, tax refunds), and refinancing to a shorter term or lower interest rate, ensuring your lender allows extra payments and there are no prepayment penalties to significantly reduce interest and shorten the loan term.
You could get out of your current car loan by refinancing, selling your car or by giving it back to your lender as a voluntary repossession. Voluntarily repossessions negatively impact your credit score for up to seven years. Refinancing or selling it might be your best options.
Our 20/3/8 rule includes putting at least 20% down on any car you buy, paying it off in 3 years or less, and keeping your total car payment(s) to 8% of your gross income or less.