Over the course of a loan, interest can really add up. However, there are several strategies that you can employ to reduce the amount of interest paid over the life of the loan, ranging from securing a favourable loan at the outset, to adopting smart repayment practices during the loan.
Before Obtaining a Loan
It goes without saying, to save yourself interest, focus on securing a loan with the lowest possible interest rate. This begins with understanding your credit score. Lenders typically offer better interest rates to borrowers with higher credit scores, as they are deemed less risky. Before applying for a car loan, review your credit report and address any inaccuracies or areas of concern. If possible, work to improve your credit score by paying down debt or resolving any outstanding issues. Even a small improvement in your credit rating can result in a lower interest rate, saving you a substantial amount over the term of the loan.
You will also want to shop around for the best deal. Do not accept the first loan offer you receive from a dealership or bank. Instead, compare rates from different lenders, including credit unions, online lenders, and your bank. Some financial institutions may offer promotions or better terms for existing customers, so it is important to explore all options. Additionally, obtaining pre-approval for a car loan can give you more bargaining power at the dealership.
The size of the deposit you put forward can also affect the amount of interest you will pay over the life of the loan. By making a larger deposit, you reduce the loan principal — the amount you borrow — which directly reduces the total amount of interest paid. For example, if you make a 10% deposit instead of 5%, you will owe less money and, therefore, pay less in interest over time. Larger deposits also bolster your case to secure a lower interest rate, as lenders may view you as a less risky borrower when you have more equity in the vehicle from the outset.
Another strategy is to look at shortening the loan term. While longer-term loans may offer lower monthly payments, they generally come with higher interest rates and result in more interest paid overall. A loan with a term of three or four years will typically have a lower interest rate compared to a loan with a term of five or six years. Though the monthly payments may be higher on a shorter-term loan, you will pay off the loan faster and incur less interest in the process.
Finally, avoid adding unnecessary extras to your loan, such as extended warranties, service contracts, or other add-ons that can increase the loan amount and, therefore, the interest paid. Many dealerships offer these extras, which may seem convenient, but financing them through your car loan will lead to higher interest costs. If you do choose to purchase additional products, consider paying for them separately instead of rolling them into the loan.
While Paying Down the Loan
Making extra payments or paying more than the minimum each month can also reduce the amount of interest paid. Many car loans allow for additional payments without penalty, meaning you can apply extra money towards the loan principal. By doing this, you shorten the duration of the loan and reduce the total interest that accrues. For example, making one or two extra payments a year, or rounding up your monthly payment to the nearest hundred, can significantly reduce the loan balance and the interest due over time.
Meanwhile, you may wish to consider refinancing your car loan, especially if your financial situation has improved or if interest rates have dropped since you took out the original loan. Refinancing involves replacing your current loan with a new one, ideally at a lower interest rate. This can save you money on interest, though it is important to carefully consider the terms of the new loan, such as any fees associated with refinancing, and ensure that it makes sense financially.
The Fincar team is here to help you with all your financing needs. Contact us today to help arrange your next car or equipment loan.