How To Get The Most Out Of Your Car Loan
Dan’s Unconventional Approach to His Car Loan
As I’ve posted earlier in this blog, my wife and I purchased a new car in December, 2016. The price was worked down to $26,000 and we put $9,000 down meaning we took a loan for $17,000 at 2.05% APR for 36 months. If I paid the loan off on the 36 month schedule, I’d pay $487.29 per month and $542.62 in interest total, so roughly one extra car payment.
Unlike a mortgage, I know with almost certainty that my 2017 Hyundai Santa Fe is a depreciating asset and will not become a classic car coveted by collectors one day. I’ve paid down to $1,300 remaining on the loan as of today. I want to pay of this “bad” debt as soon as I can, but I want my credit score to remain high too.
So what’s the conflict?
Well, a couple things, and let’s start by taking a look at how a credit score is calculated.
Source: http://www.myfico.com/credit-education/whats-in-your-credit-score/
If I pay off my loan, it also closes it, which has several negative factors:
- Amount owed – you’d think this would be a good thing, but the easiest way to think of this is the credit reporting agencies take all the money you owe and divide it by your credit limits (or original loan amounts). So, by paying it off too early, I take the $17,000 denominator out of my credit loan and my debt to credit ratio and my mortgage which is only 2% paid off takes a larger role in my amount owed than it does currently.
- Length of credit history – with an account that lasts only 6 months, that will be reported for years on my credit score that I had a very short credit with one lender. Longer credit histories with lenders are better for your score.
- Credit mix – This is my only installment loan.
Straight from the FICO website:
FICO® Scores will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It’s not necessary to have one of each, and it’s not a good idea to open credit accounts you don’t intend to use.
So, while it certainly doesn’t make sense to take out loans you don’t need, my wife and I needed this one for the car. We may as well get the benefit of the improvement to our credit scores (the loan is in both of our names partially for this reason).
To date, I have paid $120.74 in interest, which, I admit sucks, but the alternatives are worse: not having a car or buying at the wrong time, or being forced to buy when I don’t have options and the seller won’t negotiate knowing I need to buy a car. I’ll keep you all updated, buy my plan from here on out is to make my regular $509 monthly payments until I only have a few dollars left on the loan, and then just pay a dollar or so each month until the 36th month when I close it out. This way, I minimize the cost of the loan while maximizing the credit benefit.
Dan’s Economist Brain vs. His Personal Life
I admit, this may not (read: probably is not) rationally be the mathematically most beneficial thing to do, if I assume I can get a better than 2.05% return in the market (which I do expect, over the long run). I could earn more money in the market if I put my money there (which, I already have a substantial sum). However, part of the rational benefit is having such a high score over a long period of time which will keep my cost to borrow in the future low.
I could reap most of the same credit reporting benefits by paying the minimum each month to close it in 36 months. Personally, I also have some job uncertainty in the next couple of years, and would like to make that as friction-free as possible, partially meaning, I do not want to change jobs with debt on a depreciating asset on my hands. In the near future, I’m going to be putting all of the money that would have gone towards the car loan and put it towards long-term savings in the market, enhancing my emergency fund, and creating a fund that will allow me to comfortably sustain me and my family while I transition jobs in the future.
Results Thus Far
Credit Score at beginning of loan: 774 (mine) / 704 (my wife’s)
Current Credit Score: 804 (mine) / 719 (my wife’s)
So it’s definitely having a positive impact, and these latest scores don’t take into account the latest (large) payment I put towards the car.
I expect to save a little more than $387.17 on the interest I would have otherwise paid, but anticipate a significant opportunity cost from not putting that money in the market. In full disclosure, most of the money I’ve been paying the loan off with was sitting around in a CD I tabbed for this car since this last Spring. That CD was earning less than the cost of the loan, and probably not better than the inflation rate, so, I take rational solace in that.
