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Should I Pay Off My Car Loan Early?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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The average new car loan term is nearly six years (5 years, 8 months), with used car terms right on its heels at nearly 5 years and 5 months. At the same time, those loans are becoming more expensive as car prices and interest rates creep upward.

A long-term auto loan sounds tempting — it may make the car you want seem affordable thanks to a relatively low monthly payment. But you may receive a higher APR than you would with a short-term loan and you’ll most likely pay more in interest in the long run.

There’s a way to avoid this. Paying even a small amount toward your loan principal could shorten your loan. If you can afford to pay off the entire balance, here are some points to consider.

Pros and cons of paying off a car loan early

Here are four benefits to paying off your car loan early:

  • Saves money on interest
  • Simplifies bill paying
  • Never have to worry about owing more on the car than it’s worth
  • Makes it easier to sell car

Here are four downsides to paying off your car loan early:

  • May deplete your cash reserves
  • You may have a lower interest rate on your car loans than on other debts
  • Missed opportunity to build credit history by making car payments
  • Possible prepayment penalties

How much could you save by paying your car off early?

If you are paying even moderately high interest on your car loan over an average amount of time, you might be surprised by how much that loan may cost you. For example, a borrower who buys a $30,000 car (sales tax excluded) on a 5-year loan at a 7% rate will pay an estimated $5,642 in interest. Compare that to $4,483 if they paid it off in just four years — that’s a difference of $1,159. If they take out a 3-year loan, the savings are even greater — only $3,347, with a difference of nearly $2,300 from the original 5-year loan in our example.

Even if you can’t afford the higher payments that come with a shorter-term loan or you aren’t able to pay the entire balance off right now, here are some ways you could pay off your auto loan this year.

When paying off a car loan early makes sense

You should consider paying off your car early if:

  • You have no other debt besides your mortgage, and you want to be rid of monthly car payments so you can free up money for other things.
  • You have a lump sum available or enough leeway in your monthly budget that you could pay off your loan without sacrificing your emergency fund or other important financial goals.
  • You want your monthly expenses to be lower by a certain point; for example, before you expand your family or by retirement age.
  • You need to improve your debt-to-income ratio; for example, if you are planning to apply for a mortgage.
  • Making a goal to pay off your car debt will motivate you to take charge of your money and start reaching toward other financial goals.

When paying off a car loan early might not be a good idea

Consider sticking to your original payment plan if:

  • You have insufficient backup cash for emergencies. “The first thing you have to look at is if you have an emergency savings fund built up, with a minimum three months in living expenses,” said Kris Alban, executive vice president of San Diego financial wellness company iGrad. “You have to have that emergency savings before you start to look for areas to cut down on debt.”
  • You are paying higher interest rates elsewhere. As secured loans, some car loans have low interest rates. “If it’s a low interest rate, under 5 percent, I would look to do other things with that money,” said Alban. “You’re probably better off using that money to invest in your retirement.”
  • You want to build your credit report by making car payments. Making car payments can help your credit report in two ways. It adds to your history of on-time payments, and improves what FICO calls your credit mix — your history of having credit cards, installment loans, and other accounts. “People think more than one credit card will fix their credit mix, but no,” said Alban. It especially helps to have more than one type of credit if you don’t have much else on your report.
  • Your initial car loan period is relatively short. If you signed up for a three-year payment plan when you purchased your car, for example, you may be perfectly happy paying it off as planned. You’re already minimizing your total interest expense, and you may be able to drive your car for years after you’ve forgotten what car payments are like.
  • Your car loan agreement includes prepayment penalties. “Always check the prepayment terms for your loan,” said Alban. “Prepayment penalties used to be a lot more common.” If you do make extra payments, be sure your lender applies them to the principal amount of the loan.

More ways to replace your car loan

Paying off your car loan isn’t the only way to save on interest expense. If you have a high-interest car loan, instead of paying off your loan, consider one of these options:

  • Draw on a low-interest line of credit. If you have a home equity loan with a lower interest rate than your car loan, for example, you may want to take cash from your line of credit to pay off your auto loan. Be aware, however, that you can generally no longer deduct interest from a home equity line of credit on your tax return, unless you use the proceeds to buy, build, or substantially improve your home.
  • Borrow from a relative or friend., If you’re paying 6 percent, say, on your auto loan, and your mom gets less than one percent on her savings account, perhaps you can work out a deal. You can borrow from her and pay her a better rate of return than she is getting at the bank. You should only borrow from relatives and friends if you have a solid relationship, and if you are not endangering their financial well-being if you should lose your job or something else goes wrong. Be sure to put any financial agreements in writing.
  • Refinance your car. This can be especially helpful if you have improved your credit since you purchased your car, and you now qualify for better rates, or if interest rates in general have gone down. Consider starting your auto refinance shopping with LendingTree, where there are dozens of lenders waiting to compete for your business.
LendingTree
APR

As low as
3.99%

Terms

24 To 84

months

Fees

Varies

SEE OFFERS Secured

on LendingTree’s secure website

LendingTree is our parent company

LendingTree is our parent company. LendingTree is unique in that they allow you to compare multiple, auto loan offers within minutes. Everything is done online. LendingTree is not a lender, but their service connects you with up to five offers from auto loan lenders based on your creditworthiness.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Sally Herigstad
Sally Herigstad |

Sally Herigstad is a writer at MagnifyMoney. You can email Sally here

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Auto Loan

Understanding Extended Car Warranties

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

Extended warranty
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When you buy a car, having a manufacturer’s warranty that covers certain repairs and services can give you extra peace of mind. If that manufacturer’s warranty is a good idea, wouldn’t a longer warranty, or “extended warranty,” be even better?

Possibly. Whether buying an extended warranty is right for you depends on a number of things. Before you decide to buy one, make sure you understand what extended warranties really are, and how they work.

What is an extended warranty?

An extended warranty is not a warranty as defined by federal law, according to the Federal Trade Commission. Manufacturer warranties come with the car and they don’t carry an extra fee.

“Extended warranties,” on the other hand, always cost extra. They are actually service contracts, under which the provider promises to perform, or pay for, certain repairs or services.

What does an extended car warranty typically cover?

An extended car warranty, or vehicle service contract, covers certain types of repairs in addition to or after the manufacturer’s warranty ends. They generally cover:

  • Mechanical breakdowns. Different types of breakdowns may be covered for different periods of time or numbers of miles.
  • Other specifically covered services and problems. For example, some contracts offer services such as free oil changes, if specified. (Some dealer incentives that include oil changes are not part of the extended warranty.)
  • Extra coverage with more comprehensive plans. With certain plans, you may be entitled to towing services, a rental while your car is in the shop, or travel insurance.

What does an extended warranty not cover?

Extended warranties generally don’t cover predictable care and servicing of a vehicle. For example, warranties may not cover:

  • Running costs such as windshield wipers, brake pads and other regular maintenance, unless specified by your contract. Tires are generally not covered by extended warranties; however, most tires are protected by some kind of tire manufacturer warranty if they wear out prematurely, according to Edmunds.
  • Your warranty deductible. You may have to pay $100 per visit or per part, for example.
  • Problems due to lack of maintenance. Neglecting to check or change the oil, for example, may void your warranty.
  • Diagnosis costs. If a mechanic must tear your engine apart, only to find out the problem is caused by non-covered parts, you may have to pay for the parts and labor.
  • Problems caused by “normal wear and tear.”
  • Anything not listed as covered. The Federal Trade Commission (FTC) advises that if an item isn’t listed, you should assume it’s not covered.

When should you consider an extended car warranty?

An extended car warranty can be a good idea in certain circumstances; for example if:

  • You need a predictable budget. An extended warranty can protect you from covered major repair expenses. Be aware that the warranty won’t cover everything, however.
  • You understand what is and isn’t covered by the contract. Take time to read the fine print, before you sign.
  • You can meet all the contract requirements. Extended car warranties come with rules about regular maintenance. You may be required to have free services done at the dealership, or by approved companies.

Under the Magnuson-Moss Warranty Act, enforced by the FTC, your contract cannot be voided because you or another mechanic performed routine maintenance and repairs on your car that would not be free under your contract.

When should you skip an extended car warranty?

  • When the service contract overlaps with your manufacturer’s warranty. Manufacturers’ warranties on new cars generally offer coverage for at least three years or 36,000 miles, whichever comes first. Your extended warranty probably does not offer you benefits until the manufacturer’s warranty ends, according to the FTC.
  • When a nontransferable contract may last longer than you own the car. Some contracts cannot be transferred, or they require a fee in order to transfer the contract when you sell the car.
  • You live far from the service location. Some contracts only offer service that is included in the contract in a certain location. If you bought your car out of town, or if you later move, that might be inconvenient or impossible.
  • If you are pressured to buy the extended warranty. Some dealers may give you the impression that you are required to buy the contract or that you can’t get financing without it. According to the FTC, you are generally not required to buy an extended warranty either to purchase a car or to get financing for it.

Shopping around for extended car warranties

Make sure you know these things before you sign:

  • Who provides and administers the service contract? Dealers sometimes make it seem you can only buy extended warranties from them, and that they are providing the service contracts. Service contracts can actually be provided by the dealer, the manufacturer, or a third party. They may be handled by an administrator.
  • Who is obligated to fulfill the contract? Find out who backs your contract if the provider or administrator goes out of business, and if the contract is backed by an insurance company.
  • Who is selling you the warranty? If you got a robocall about the warranty on your car, be careful. The FTC describes phone pitches for extended warranties as often “high pressure,” and says they may demand personal information. Some calls are actually scam artists trying to get your Social Security number, bank account number, and other information.

Factory warranties vs. third-party warranties. While an extended manufacturer warranty is only available from the manufacturer, you can shop around for your own extended warranty. You could also call dealerships in your area to compare going rates. At the very least, you’d be armed with a few quotes before buying your new car though you could add an extended warranty at any time, as long as the car is within limits of age and miles. AAA offers extended warranties as may other motor clubs in addition to private companies.

Negotiating an extended car warranty

Negotiating to purchase a car doesn’t stop with determining the cost of the car you’re purchasing and how much you pay for an auto loan. You may also have room to negotiate the cost and benefits of your extended car warranty.

Get your best deal on a warranty the same way you got a deal on your car. Know as much as possible before you get there, including whether you are even interested in a service contract. Don’t necessarily take the first price you hear. And be willing to say “no” if the deal doesn’t sound like it’s in your best interest.

Alternatives to buying extended car warranties

An extended warranty isn’t the only way to handle car expenses or unexpected repairs. Consider these alternatives for managing your risk:

  • Budget for car service and repair expenses yourself. Car maintenance is expensive. Buying a service contract doesn’t make the expenses go away — you just pay for them another way. Work toward maintaining enough in your savings to pay for both predictable expenses (such as tires) and less predictable expenses (like transmission trouble). You might start your savings fund with the money you don’t spend up front for an extended contract.
  • Buy a more dependable, easy-to-fix car. Some cars are in the shop more often — and cost more every time they go there. Ask your mechanic which cars he recommends. You could also check out recommendations from organizations such as Consumer Reports or research ratings from government agencies such as the National Highway Traffic Safety Administration or Insurance Institute for Highway Safety.

After you pay for a warranty

Keep an eye out for written confirmation of your service contract. It shouldn’t happen, but the FTC says some dealers take the money from extended warranty sales and neglect to forward the payment to the administrator or third party, leaving the buyer without coverage.

Be sure to maintain your car as required under your contract, and keep your receipts. For one thing, your contract may be void if you don’t. More importantly, a well-maintained car is less likely to need major repairs. The only thing better than having a big repair bill covered by a contract is to not have your car break down at all.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Sally Herigstad
Sally Herigstad |

Sally Herigstad is a writer at MagnifyMoney. You can email Sally here

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Best of, Building Credit, Life Events

What Credit Score Is Needed to Buy a Car?

Credit score to buy a car
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If you want to buy a car, you can probably find someone willing to sell you one and give you a loan, regardless of your credit score. But you might be shocked when you see what it will cost you. Car buyers who need a loan and don’t have a good credit score often end up paying more — a lot more.

Even if you have an average or better credit score, exactly how good it is can dramatically affect how much you pay to finance your car.

Fortunately, by learning about credit scores and how they affect your car loan, you can take steps to make sure you always get your best deal. Read on to learn how.

Buying a car? What’s your credit score?

The better your score, the better the auto loan deal you can get. That’s because if you have a proven track record of borrowing money and paying it as promised, lenders aren’t taking a big chance giving you a loan. They might even compete for your business by offering you low interest rate loans.

If your payment history is sketchier, you’re a riskier bet in the eyes of prospective lenders. You may quit paying, and they’ll have to take steps to collect. Lenders expect compensation for extra risk in the form of higher interest rates.

This chart shows how much your credit score can affect the amount you pay to finance your car.

Average Car Loan Rates by Credit Score, Third Quarter, 2018

Credit Score RangeNew Car LoanUsed Car Loan
781 to 8503.68%4.34%
661 to 7804.56%5.97%
601 to 6607.52%10.34%
501 to 60011.89%16.14%
300 to 50014.41%18.98%
Source: Experian

Do auto lenders use the same credit score as other lenders?

Credit bureaus offer a wide variety of credit scores to help meet lenders’ needs. Because auto lenders place more importance on certain credit information, such as your history of making car payments, the credit score an auto lender sees may be slightly different from the score pulled by other lenders.

What else do auto lenders look at besides my credit score?

Auto lenders look at several factors in addition to your credit history and credit score. According to the Consumer Financial Protection Bureau (CFPB), they’ll also consider how much income you have, your existing debt load, the amount of the loan you are applying for, the loan term (how long it will take you to pay it back), your down payment as a percentage of the vehicle value, and the type and age of the vehicle you are purchasing.

The most important things car lenders consider when you apply for a loan, however, are your credit score and credit history. “You can even get a car loan when you are unemployed, provided you have a down payment and money in the bank,” said Nishank Khanna, chief marketing officer at Clarify Capital, a business lending firm in New York City.

How can I increase my odds of getting a low-interest car loan?

If you want to get the best deal on a loan, follow these steps before you go to the dealership:

  1. Check your credit report before you look for a car. According to Experian, you should check your credit report at least three to six months before you make a major purchase. This gives you time to correct any mistakes on your report, if needed.
  2. Try to improve your score, if needed. One quick way to pump up your credit score is to lower your utilization rate, preferably by paying down your consumer debt. Even if you’ve never missed a payment, your credit score suffers if you’re using too much of your available credit when lenders report to the credit bureaus. Alternatively, you can ask for a credit limit increase, and instantly improve your utilization rate. (Just don’t use that available credit, or you’ll be worse off than before.)
  3. Avoid making major purchases or applying for other new credit right before you want a car loan. Applying for credit creates “hard inquiries” on your credit report, which can temporarily ding your score. In addition, new debt can change your debt-to-available-credit ratio, or increase your debt load.
  4. Know what you can afford. “Always get a car that you can realistically afford in terms of the car payments, not necessarily what you would like to have,” Khanna said. Stick to your decision, no matter how persuasive the salesperson can be.
  5. Find a cosigner, if necessary. If you have just entered the workforce, for example, you may not have a significant credit history. “You may need to have someone cosign your loan to get a decent interest rate,” Khanna said. A cosigner can be a parent, sibling or even a friend. The cosigner will be liable for the debt if you don’t pay, so make sure you can comfortably make the payments, and that you won’t put the cosigner’s finances at risk if something goes wrong.
  6. Shop around. Sure, it’s easy to apply for a car loan at the dealership. But you probably don’t buy cars without shopping around. Why would you sign up for a car loan at the first place you go? You can even find a good deal and get preapproved for a car loan. As a car buyer, it is wise to make sure that you are getting the best deal that you can qualify for. Consider starting your search with LendingTree, our parent company.  On LendingTree, you can fill out an online form and receive up to five potential auto loan offers from lenders at once, instead of filling out five different lender applications.

LendingTree
APR

As low as
3.99%

Terms

24 To 84

months

Fees

Varies

SEE OFFERS Secured

on LendingTree’s secure website

LendingTree is our parent company

LendingTree is our parent company. LendingTree is unique in that they allow you to compare multiple, auto loan offers within minutes. Everything is done online. LendingTree is not a lender, but their service connects you with up to five offers from auto loan lenders based on your creditworthiness.

Avoid dealerships that advertise “no credit check” or “buy here, pay here.” These dealerships specialize in sales to buyers with poor or no credit and make their own in-house loans. According to the CFPB, you may not only pay high interest rates to places that specialize in buyers with poor credit, but you may pay thousands of dollars more for your car than you would elsewhere. If these are the only dealerships where you can get a loan, consider walking away.

“If your credit score is less than 500, you may be better off getting a car you can afford to buy outright with cash,” Khanna said. You can always get a nicer car when your credit improves.

While you’re comparing car loans, remember to pay attention to the total cost of financing your car. Your interest rate is just one factor in determining your total interest expense. You can also reduce your interest cost by making a larger down payment, paying off your car sooner, and by purchasing a less expensive car.

You have plenty to think about when you’re shopping for a car. You shouldn’t have to worry about your loan at the same time you’re checking out features and searching car lots. Get a head start on financing, before you go shopping, and you’ll have one less thing to worry about while you test drive your next car.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Sally Herigstad
Sally Herigstad |

Sally Herigstad is a writer at MagnifyMoney. You can email Sally here