Most of us will carry a car loan some time our lives. Many of us will carry more more than one, either simultaneously or in succession. Car loans tend to be smaller than other types of loans (such as a home mortgage), but they’re still not something to take for granted. Consider: the average cost of a new car tops $30,000. For a used car, the average cost is over $18,000. These aren’t small amounts! So, if you do take out a car loan, be sure to give it the attention it deserves.
How do you manage car-related debt as advantageously as possible for your overall financial picture? Here are some suggestions.
- Observe the 20% rule. As a general rule, your monthly car payment should never exceed 20% of your monthly income. Obeying this rule of thumb will ensure that you have enough money to spend on other monthly expenses, plus a little extra to put into your savings.
- Make extra payments. If you find that you’re spending more than 20% of your monthly income on your car payment, it’s time to make adjustments. As circumstances permit, save up to put extra payments against your car loan, which will reduce the principal. Do this until your monthly payment is at or below 20% of your income. Making extra payments whenever possible will help you pay off the loan more quickly (for less accumulated interest).
- Refinance to get a better rate. Interest rates on car loans these days are pretty low (3% and below) due to competition from lenders, so you don’t have to worry about paying off your entire car loan right away. If you are paying more than 3% interest, however, you should consider refinancing. You may also consider refinancing to lengthen the term of your loan to lower your monthly payment. If you pursue refinancing, be careful to inquire about any fees you may end up paying and consider those in the overall calculation of how much you will save by refinancing.
- “Downsize” your car. Owning a car may be a necessity, but owning the newest, fanciest, most expensive model probably isn’t. If you’re trying to get your loan payment down to 20% or less of your monthly income, consider trading in your car for one that is less expensive. (While you’re researching more affordable options, don’t forget to factor in fuel efficiency and maintenance costs as well.)
- Plan ahead to your next car. Remember that you will need to replace your current car at some point, so you should balance paying off your loan and making sure you have some savings for a down payment on a new car.