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How to Budget for a New Auto Loan: Monthly Payments vs. Full Payment

December 15th, 2021 | 11 min. read

How to Budget for a New Auto Loan: Monthly Payments vs. Full Payment
Yanna

Yanna

As the Content Specialist and author of the Learning & Guidance Center, Yanna enjoys motivating others by uncovering all that's possible in the world of finance. From financial tips and tricks to ultimate guides and comparison charts, she is obsessed with finding ways to help readers excel in their journey towards financial freedom.

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Deciding how to pay off an auto loan isn’t the same for every borrower and it varies based on your spending needs. One borrower may opt into doing a monthly payment plan to establish their credit score, while another might decide to pay the total cost of the auto loan in advance and avoid paying interest. 

Savings-Style-Email_Budgeting-Tool-CircleIn my years working directly with Loan Officers, I’ve learned their best tips and practices when it comes to budgeting for and making loan payments.

In this article, I'll share those tips and help you understand the basics behind payment types and how they'll affect your credit score. Ultimately, I want to help you make the best decision when deciding on an auto loan repayment option!     

 

the pros and cons of monthly payments 

Making monthly payments are an affordable option when you have other expenses like rent and other bills, additional monthly loan payments, and savings plans.

 

benefits of a monthly auto loan
  • It Can Improve Your Credit Score - Making payments towards a line of credit is one of the highly weighted factors used to calculate your credit score. Your Payment History makes up 35% of your credit score, so having a recurring monthly payment (like an auto loan) can help you build up or establish a history.

  • You Won’t Need CollateralCollateral is something of value that you pledge to a lender to secure the loan. The vehicle you’re purchasing becomes the collateral which is a benefit since it secures the loan and also helps lower your interest rate since you’re giving the lender something they can use to recuperate the funds if you default.
Psst... The downside is if you fail to make payments, the lender can seize the vehicle. 

 

  • You’ll Be Able to Afford a New Car -  According to the analysts at Kelly Blue Book, U.S. consumers paid an average of $42,258 for a new vehicle based on June 2021 figures. With a 72-month loan term, that’s roughly $645 a month (depending on the interest rate and other factors).  Someone who’s juggling other expenses could appreciate a monthly payment option instead of coughing up the full $42,258 upfront. Monthly payments will allow you to drive away in style while on a budget!

  • You’ll Have Options of the Loan Terms -  Having options in your term gives you more time to pay back the loan. It might not be fun to have to make payments for 72-months, but the monthly payment can be more affordable and can help you save for other expenses. 

 

disadvantages of a monthly auto loan
  • You’ll be Paying Money Every Month - Even though monthly payments are not as costly as a total car payment upfront, it’s still not fun to make payments for long periods of time (like six years for a 72-month term). You’ll want to contribute funds towards other expenses.
Hint: To avoid this, budget accordingly so you can make your monthly payments while still planning to save for the future. This can be done!

 

    • You Could Pay Additional Interest - Based on your preferred lender and the term you pick, rates are typically higher for longer-term loans, and you could ultimately pay more money than the value of the car. (Psst... try to avoid long loan terms and shop around for your best rate)
    • Loss in Car Value - Various factors determine a car’s value (mileage, year, the condition of the car, etc.), and a new or used car loses its value over time due to wear and tear.  Used cars are more affected by this because the chances of a used car breaking down is greater than a new car experiencing any type of engine or operating failure. Depending on how long your loan term is, you may end up owing more money than the car is worth.  

how do the monthly payments affect my credit score?

Just having an auto loan affects your credit score. Your payment history makes up 35% of your score, when you make monthly payments on time, you're increasing your score by establishing a good payment history. 

If you’re behind 30 or more days of missed payments, lenders see you as a risk, your car can be repossessed and your credit would be ruined.  If you are looking to establish a credit history, making on-time monthly payments on an auto loan would be the way to go.

Learn More About Credit Scores

 

what are the pros and cons of paying the total cost of an auto loan?

Determining how to pay off an auto loan depends on your budget and the circumstance, as well as your preference when it’s time to repay the loan. As we learned above, monthly payments are beneficial if you’re looking to establish or improve your credit score. However, paying off an auto loan in full comes with some benefits, too:

 

benefits of paying off the total cost of an auto loan
  • You'll Have More Money in Your Pocket - With no monthly payments towards an auto loan, you’ll have extra cash on hand to spend on other priorities such as education expenses or debt, rent or mortgage, utilities, and your savings goals. 

  • You’ll Save Money on Interest - With each monthly payment you make, a portion goes towards your interest (a fee for borrowing the auto loan in the first place), and the rest goes towards your principal (money that you originally agreed to pay back).  Paying off the entire auto loan upfront can reduce the interest paid on your loan tremendously.  

  • You Have Full Ownership of Your Car - Once you pay off the car, the car title is YOURS and no longer belongs to the lender. 

  • Your Debt-to-Income (DTI) Ratio is Improved -  Your DTI ratio is a percentage that represents your monthly debt payments and tells a lender if you can afford the loan. When you pay off your car loan early, your DTI lowers. And, the lower your DTI, the better you look to creditors and lenders in the future!
  •  
disadvantages of paying off the total cost of my auto loan
  • You'll Have a Lower Credit Score (Temporarily) - Anytime an account is closed, there is a drop in score because a tradeline was closed.  You also have the impact of the loan no longer reporting to the bureau, which means you're not actively increasing your score.   
     
  • Prepayment Penalties - Depending on your lender and your term, there may be payment penalties, which means paying a fee if you pay off your auto loan before the end of the term.
QUICK TIP: Charlotte Metro doesn't do this, but other lenders commonly charge a prepayment penalty. Ask your lender if this is a possibility.

 

what happens if i pay more than my monthly payments?  

If you’re like most borrowers who dread having debt, then paying more than the agreed amount on an auto loan bill is a way of paying off an auto loan early. You’ll be paying off your principal faster and you’ll reduce any accrued interest. But to do this, you’ll need to have extra room in your budget. 

Here’s a chart to better help when choosing a repayment option that'll work for you:  

Reason

Monthly

Total Cost

I want to improve my credit score

 

I don't have enough money to afford the full payment.

 

I'm saving for another big purchase.

I really want to avoid paying the loan interest. 

✔ 

I want to buy a new car.

I can afford the loan.

 

I don’t have outstanding debt  

 

 

how can i budget for an auto loan?

I recommend budgeting apps that will help track your spending, like Truebill. It’s an all-in-one financing app that can track your spending, help you lower the cost of your bills, as well as cancel subscriptions.

You can also use the resources offered in The Basics of Building Your Budget.  I share some fun tips and tricks as well as budgeting tools that will get you on track with expenses - my favorite budgeting tool is the cash envelope system.  

Psst… Don't forget to download Charlotte Metro's Smart Budgeting Guide if you haven't done so already. It's packed with tips, tricks, and a handy template-  Check it out! 

   

how do I calculate my monthly auto loan payments?

Oh, that’s easy! You can calculate your monthly payments by knowing your auto loan amount, the term or duration of the loan, the interest rate, and fees!  Feel free to add your calculations below:

 

here's what'll help you determine the payment option that works for you   

Before you apply for your auto loan, look at your finances and see how much you can realistically afford. If you have more than enough funds to buy 2 cars at once then you can afford to make a total payment on an auto loan. This will allow you to focus on other big-ticket items like mortgage payments, big trips, or your savings. 

If you don’t have enough money saved to buy a car twice at the same time, I suggest opting into monthly payments. You can enjoy a new car while on a budget when opting into monthly payments.

Either way, once your auto loan is paid in full  - it’ll be time to do a happy dance because you’ll be an official car owner,  with your car title and all - Woo hoo!