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Does it Matter How Fast I Pay Off My Car Loan?

If your monthly payments are on time, how fast you pay off your car loan only matters in terms of interest costs. Auto loans use a simple interest formula, so the quicker you can pay off the loan, the less it can cost you.

The Cost of a Long Auto Loan

Borrowers are typically advised to take on the shortest loan term they can comfortably afford, which also means paying off the loan as fast as you’re able.

The old standby advice for car buying is the 20/4/10 rule. It advises a short loan term, which is great advice for any borrower. It states that you should put 20% down on a vehicle, have a four-year loan term, and all vehicle expenses should make up less than 10% of your income (including gas, insurance, maintenance, and car payment). However, the 20/4/10 rule is really more of guidance these days, since the rising cost of vehicles is making borrower costs increase – but a short loan term is still valid advice because of how auto loan interest is calculated.

Auto loans almost always use a simple interest formula. This means your interest charges over the course of the loan are determined by the length of the term, your loan balance, and your interest rate. Every payment you make partially goes to your accrued interest charges, and the rest is applied to the principal.

The faster you pay down the loan, and the larger your payments are, the less time interest has to accrue. And, if you take on a bad credit auto loan, it’s an even better idea to opt for a shorter loan term because you’re more likely to qualify for a higher interest rate.

Your loan term can make a big impact on how much you pay for a car, so how fast you can pay it down can determine how much it costs you to finance:

 Car Loan A: 84-month loan term 

  Car Loan B: 60-month loan term 

$20,000 loan balance

$20,000 loan balance

13% interest rate

13% interest rate

$363.84 monthly payment

$455.06 monthly payment

$10,562 total interest paid

$7,304 total interest paid

Just by choosing a shorter loan term and changing nothing else about the loan, it can save you thousands of dollars and get you to vehicle ownership faster. In the case of our examples, choosing a 60-month loan term over an 84-month loan term means saving $3,258. Financially speaking, a short loan term is the smart, clear choice.

What if I Have to Choose a Long Loan Term?

There may be a time when you don’t have a say in the length of your loan term. Your credit score, income, and the loan size you need can all have a say in what loan terms you qualify for.

If you have no choice but to go with a longer loan term, then it’s a good idea to have a large down payment. A down payment is directly applied to the vehicle’s selling price, which means you borrow less, and that means less interest accrues over the course of the loan.

Does Loan Term Impact My Credit Score?

In terms of credit repair, a longer loan term can benefit you. Payment history comprises 35% of your credit score, so the more timely payments you have reported, the better your credit rating will be.

However, any loan term can still do wonders for your credit score as long – as you’re maintaining the other aspects of your credit score, too! There’s always potential credit repair if you’re staying current on your loan, and a completed car loan on your credit reports looks great to future lenders.

Keep in mind, too, that the longer you have a loan, the more risk you can put yourself in. If your financial situation gets rocky in the near future, and you still have years left on your loan term, it could mean damage to your credit and/or trouble maintaining the loan in the future. Negative equity is more of a risk with a long loan term, as well, since you may struggle to pay your car down as quickly as it’s depreciating.

Finding Your Next Auto Loan

In terms of your personal financial health, a shorter loan term can mean owning the vehicle free and clear faster. A lender may give you the option of choosing a 96-loan term, and it’s a big financial decision, and a much bigger commitment compared to having a car payment for 48 or 60 months.

You can compare the benefits of a short loan term to a long loan term all day, but if you can’t find the lenders you need for your credit score, it can be all for naught. Here at Auto Credit Express, we’ve created a nationwide network of special finance dealerships that are equipped to work with many unique credit situations. Complete our free auto loan request form, and we’ll look for a dealer in your local area that can assist with credit challenges.



Source: on 2021-08-19 09:47:24

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