Was Paying Off My Car Early Worth It?

Date: 2019-06-03

Time to Read: 7 Minutes

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Photo By: unsplash-logoKarsten Würth (@karsten.wuerth)

I sat in my cubicle in Tupelo, MS, blissfully unaware of the predicament that had befallen my poor wife in Memphis. Despite her continuous phone calls that failed to connect, I would only learn of the situation hours later.

Nothing quite focuses the mind like your vehicle suddenly stopping and turning off in the middle of four lanes of traffic on I-240 in Memphis, TN. And that’s exactly what happened to my wife. And that’s exactly what prompted the following realization.

We had to get a new vehicle.

Okay, so maybe this wasn’t the immediate thought. After eventually getting the vehicle to start back up and removed from the busy road and subsequently repaired (“failed sensor”), we were warned that this older car was beginning its death throes and that it would be only a short matter of time before we would experience more devastating issues.

Though shortly after the beginning of our marriage we had decided that we would only visit the possibility of purchasing a newer vehicle once the previous one had completely died, this situation was less than ideal. We didn’t expect this reality to come so quickly. But we both had stable jobs and we were prepared to make our first big adult purchase as a married couple: a new vehicle.

Auto sales negotiations were an unfamiliar territory for me. I tried to familiarize myself with terms like MSRP (Manufacturer’s Suggested Retail Price), Dealer’s/Wholesale Price, Dealer’s Hold-Back Price. We had somewhat settled on a type of vehicle; my wife had always wanted a Jeep Wrangler; so I familiarized myself with the various trim-levels and used different online resources to estimate prices and scour nearby listings (TrueCar and CarGurus, respectively).

We visited several dealerships. Probed their salespeople with questions. Eventually, at one point, I decided to actually go as far as sit down and proceed with price negotiations. Frankly, it went nowhere.

The vehicle was a Jeep Wrangler Unlimited Sport, I don’t remember the model’s year but I’m guessing it was around 2013-2014. It had no power windows. It cost >$30,000.

Using my newly acquired negotiation skills, I shaved a few hundred off of the dealer’s price (woo…). Next, came the financing portion. The dealership’s financing officer fetched a few possible loan considerations based on my wife and I’s credit score. The lowest was still >15%. I may have been fairly ignorant to this aspect of negotiations, however I knew that this interest rate was extremely high. I asked for a second try and the financing officer came back with an interest rate of ~10%. Still terrible.

~30,000+ financed at ~10% without power windows. I walked out. And after later test driving a Jeep Wrangler at a different dealership, we decided to go a different direction entirely. A car.

And that’s when I set my eyes on a 2014 Nissan Maxima at Car Max. It was competitively priced, the dealership featured no haggling, so for better or worse, I wouldn’t have to worry about hours of endless back-and-forth negotiations. My wife was a fan and familiar with Nissan vehicles and altogether it seemed like the ideal choice.

After a short test drive, we sat down and commenced the closing session of the sale. Unbeknownst to my wife, I had already planned to buy the vehicle before arriving at the dealership and the test drive was simply a formality to affirm my decision.

We decided to finance through the dealership’s financing center and after paying our down payment; we agreed to the following terms:

$25,966.90 at 6.40% APR for 72 months…

Alas, it was much better than the terms of the Jeep Wrangler mentioned above.

Our monthly payment was $436.27 which we felt was low enough that we could pay extra on the principal.

Congratulations, we were officially in debt.

This was May 2015. According to the terms of the loan, it wouldn’t be until May 2021 before the loan would be paid off in full if we followed the payment schedule. With interest included, this effectively turned $25,966 into $31,339, nearly $5,400 of interest payments!

A year passed and we never paid anything more on the principal, predictably. A common lesson for people purchasing anything on a loan is to avoid being lulled with the illusion of lower monthly payments resulting from stretching out the length of the loan, but to always consider the total cost of the loan itself. Opposite of this is the idea that a lower monthly payment allows you the freedom to choose to pay extra on the principal, invest the difference, or lessen the financial strain of the expense during troublesome times.

We thought that we would be disciplined enough to continuously pay extra. However, these good intentions were continuously sidelined and in December 2016, I realized we had simply stuck to the schedule as is. It was also around this time, I began re-investigating the terms of our loan and wondering if we could drop our APR lower now that we had a more proven credit score.

This lead to me eventually deciding that I would refinance the car roughly a year and a half after the initial purchase. Which leads to the story in Why I Left My Regional Bank.

Thus in January 2017, I decided to use PenFed credit union to secure a refinance auto loan. By this point, we had paid up to $8,725.40 in car payments, bringing down the principal balance down to $19,699 so roughly $6,267.36 (or ~72%) of the car payments total went toward paying off the principal.

One typical trap of refinancing is to further stretch out the duration of your outstanding loan. This may result in lower monthly payments, however the total cost of the loan would be more than it would have been without refinancing. However, I had roughly 52 months left on my original loan and the refinance auto loan that I was interested in had a length of 48 months.

Loan Total Cost
Car Max ($25,966.40 @ 6.4% for 72 mos) $31,339
Car Max (20 Months Paid) + PenFed ($19,699 @ 2.49% for 48 mos) $29,442

This move would save me nearly $2,000 but there wouldn’t be any change in my monthly payment. Therefore, I chose to stop procrastinating and finally make that extra payment as a single lump sum principal payment of $5,000 on the original Car Max auto loan before refinancing. Therefore, I would be refinancing a significantly smaller principal amount than originally.

Loan Total Cost
Car Max ($25,966.40 @ 6.4% for 72 mos) $31,339
Car Max (20 Months Paid) + PenFed ($19,699 @ 2.49% for 48 mos) $29,442
Car Max (20 Months Paid) + $5,000 + PenFed($14,699 @ 2.49% for 48 mos) $29,184

Granted, the total cost of the loan wouldn’t change that much. The monthly payments would drop from $436.27 to $322.75, a nearly -$114 reduction. And everything went well, the lower monthly payment elevated our savings rate allowing for me to take a few more stabs at the principal balance ($2500, $2200, $1100, $2000) from our monthly margin until January 2018 I finally placed the last nail into the coffin of the auto loan and paid off the balance in total.

Loan Total Cost
Car Max ($25,966.40 @ 6.4% for 72 mos) $31,339
Car Max (20 Months Paid) + PenFed ($19,699 @ 2.49% for 48 mos) $29,442
Car Max (20 Months Paid) + $5,000 + PenFed ($14,699 @ 2.49% for 48 mos) $29,184
Car Max (20 Months Paid) + $5,000 + PenFed (11 Months Paid) + $7800 Intermittent Payments + ($3663 Pay Off Amount) $28,739

So all in all, after the auto loan refinancing and the numerous principal payments, I managed to shave $2600 off the total cost of the loan and 41 months off the duration of the loan.

Was it worth it?

Preceding the refinanced auto loan with a significant principal payment and thus refinancing a smaller auto loan resulted in a much smaller monthly payment versus simply rolling the original loan’s current principal into the new refinance loan. This opened up an avenue to save more to eventually pay off the loan much earlier than original.

However

There are some that may argue that the difference between $29,184 and $28,739 isn’t big enough to justify paying the refinance loan off 37 months early. One could argue that the $11,463 of principal payments would have been better served invested elsewhere such as a low-cost passive index fund whose earnings would be greater than the 2.49% interest rate on the refinance auto loan.

For fun, some back of the envelope math of these two scenarios:

Strategy Total Loan Cost Savings Result
Refinance Loan Untouched -$15,458 $11,463 @ 7.0% for 48 months = $15,026 -$432
Refinance Loan Paid Off Early (37 Months) -$15,013 $323 * 37 months = $11,951 -$3062

Granted the above assumes that you invested the principal payments’ total as a lump sum at the beginning of the loan term. Also, the investment returns are also estimated and assumed to be consistent.

This is a valid argument. But by paying off the loan early, you free up ~$323 a month, you outright own your vehicle, and you have removed a weighty debt item from your balance sheet. If you’re debt-adverse, this may be the best option.

So you decide.

As for me, I’m staring down another vehicle purchase in the near future. Fun.

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About

Blake Adams is a writer, software developer, technical consultant, and financial independence enthusiast living in Oxford, MS.

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