Making an extra loan payment reduces your loan's principal balance faster, which cuts down the total interest you pay and shortens the loan term, allowing you to become debt-free sooner, but you must ensure the lender applies the extra funds to the principal, not just prepay future interest. By paying down the principal faster, you lower the amount on which future interest is calculated, saving significant money over the loan's life, especially in the early years when interest is highest.
When you increase your monthly payment, the amount of the increase gets applied directly to reducing the amount owed, or principal. Reducing the amount of money you owe will reduce your interest charges each month as the interest rate will be applied only to the outstanding loan balance.
If you repay more than the minimum monthly repayment, you'll be able to pay off the loan faster, and it will reduce the amount you'll pay on interest over the life of the loan.
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.
Credit score
Murphy explains that your creditworthiness is heavily influenced by your debt-to-income ratio. So if you're looking to boost your credit score, paying off a loan early can help. And with a better credit score, you may find it easier to secure a loan for your next big purchase.
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 two main benefits of loan overpayment are: It helps you clear your debt sooner. It may help reduce the amount of interest you are charged over the term of the loan.
The main downsides of prepaying are tying up cash that could earn more elsewhere (like investments), potential prepayment penalties from lenders, reduced liquidity for emergencies, and missing out on the time value of money, especially if your loan interest rate is low; it also means losing potential tax deductions and can complicate financial aid.
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.
Some lenders will automatically assign any additional payments toward principal. With others, you'll need to reach out to the lender to indicate the extra payments go toward principal and not interest.
For most people, increasing a credit score by 100 points in a month isn't going to happen. But if you pay your bills on time, eliminate your consumer debt, don't run large balances on your cards and maintain a mix of both consumer and secured borrowing, an increase in your credit could happen within months.
Making extra payments or picking up a side job are effective ways to pay off a personal loan faster. Tightening your budget or refinancing your loan can also help with early payoff. Early payoff can save hundreds or thousands of dollars in interest, but check for prepayment fees first before paying a loan off early.
According to Rachel Sanborn Lawrence, advisory services director and certified financial planner at Ellevest, you should feel OK about taking on purposeful debt that's below 10% APR, and even better if it's below 5% APR.
"I'm Going to Pay Cash!"
If they know you have a specific budget, they also know they won't be able to move you up to a more expensive, profitable model. So if the salesperson asks about financing, just say you're undecided.
For years, dealerships have been using a tactic called a “four square”—a sheet of paper divided into four boxes where the salesperson will write down your trade value, the purchase price of the vehicle you're buying, your down payment, and your monthly payment.
With a 700 credit score (considered "Good"), you're well-positioned to get approved for most major loans like mortgages, auto loans, and personal loans with more competitive interest rates and terms than someone with a lower score, plus you'll qualify for better rewards credit cards and may even see lower insurance premiums. You can access a wide range of financial products, but to get the best rates, scores above 740-760 are often needed.
The golden rule of credit cards is to pay your statement balance in full every single month. This practice is crucial for maintaining a good credit score and avoiding costly interest charges.