How to Get out of a High Interest Car Loan
The interest rate for many loans typically leans on one major factor: credit score. An individual’s credit score indicates to lenders a borrower’s credit risk or credit worthiness. High credit scores tend to equate to more favorable (i.e. lower) interest rates. Those with poor scores may face high interest rates.
A high-interest car loan increases the monthly car payment. High interest loans also could be longer-term loans, and these loans could lead to a borrower being upside down in the beginning of their loan. Car owners who are wondering how to get out of a high-interest car loan have three options:
- Refinance the loan
- Pay off the loan in full
- Pay more in principal each month
The Variance of Interest Rates
Interest rates for consumers may be influenced by the rate set by the Federal Reserve (aka the ‘Fed’). The Federal Reserve’s interest rates adjustments affect banks when they lend to each other. In turn, banks and financial institutions may then increase rates for consumer borrowers.
However, while there are benchmark interest rates, an individual’s interest rate for a car loan or a mortgage is influenced by their credit score. High scores tend to correlate with lower interest rates, but low credit scores signal a risk to lenders. Those with lower credit scores may face higher interest rates for their loans.
How high can interest rates soar? Depending on the loan, the rates could be double or even triple digits. For car loans, Investopedia notes that consumers with credit scores below 579 had an average interest rate of 14.39 percent when buying a new car.
In contrast, those with good scores (720 and above) had average interest rates that were less than four percent (3.65 percent). However, some dealerships could offer zero percent interest rates for borrowers who qualify. This means that borrowers would be only paying principal for their car payment; these 0 percent loans could allow qualified borrowers to build equity in their vehicle quickly.
How to Get Out of a Loan with a High Interest Rate
When a consumer buys a new car, their credit score might be lower. Maybe they had several late payments, defaulted on a loan or had some other financial issue. The lower credit score, though, might have led to a high interest rate for the new car.
Now the car owner might be looking for ways to lower their monthly payment or get out of the loan. While there are a few options, car owners might need to explore them all and weigh the pros and cons or find the option that works best.
Refinancing the Loan
If an individual’s credit score has improved, refinancing the loan could lead to more favorable interest rates. To better understand their credit score, consumers can request a free credit report once a year. Reviewing their credit report also can help consumers find any errors.
Consumers who are interested in refinancing their car loan might explore their options through their current bank or credit union. When refinancing, consumers need to review the new interest rate and the loan terms, too.
If the car owner has been paying on their loan for three years but the original loan was a seven year loan, they would have four years left on the loan. Perhaps the new loan could offer a shorter term—maybe it’s a two or three year loan. In total, the car owner would only pay for the car over five or six years (counting the three years of the original loan).
When a car owner pays off the loan in a shorter period of time, they then own the car outright and the resale value of the car represents pure equity.
Paying More Each Month
Some car owners might want to continue their current loan. However, to get out of the loan quicker, they might make extra payments to principal each month. This can be an effective way of getting out of the loan without going through the process of refinancing.
However, when making extra payments, car owners should contact the lender to inquire how to allocate the payments so they are applied to principal. Some lenders automatically apply extra payments to principal, but this might not always be the case. Talk to the lender to ensure that payments are applied as intended.
In addition, paying off more each month would allow the car owner to pay off the loan quicker. Ask the lender about any potential penalties for paying off the loan before the original payoff date.
Paying the Loan in Full
The most simplistic way to get out of a high interest car loan also could be the hardest for consumers: paying the loan in full. However, a tax refund or perhaps a new job could allow a borrower to stash aside extra money and pay a loan off in full.
Before paying off the loan, the borrower should contact the lender to inquire about the payoff balance. In addition, they also need to ask about any penalties for paying off the loan early.
Is Selling the Car an Option?
Selling a vehicle to pay off a car loan could be an option, but it’s only an option if the car owner doesn’t need the vehicle. Those who want to sell the car in order to pay off the loan can either sell the vehicle privately or sell it to a dealership.
Before selling a car with a loan, contact the lender. The borrower will need to inquire about any steps they need to take to sell the car, and they also should ask about any payoff penalties. As the lender has ownership of the vehicle, they need to be contacted.
Selling a car with a loan also can get complicated, and this isn’t a route every car owner wants to drive down. Research the car via Kelley Blue Book to find out the resale value. If the resale value is less than the loan balance, selling might not be an option.
Drowning In Interest? Explore all the Options
Car owners who are drowning in loans with high interest rates have options. Refinancing the loan can help car owners find loans with lower interest rates and/or shorter terms, too.
For consumers who just want to get out of the loan quicker, making extra payments to principal or paying off the loan in full also can be considered. However, the car owner should contact their lender to inquire about penalties for paying off the loan early.
Some car owners simply don’t have the extra cash to pay more per month or pay off their loan. Refinancing the loan could be the best option. When consumers are interested in refinancing their auto loan, they can shop around for the best interest rates.
Before going through the process of refinancing, though, consumers might consider reviewing their credit report to better understand their creditworthiness or risk. If they notice that their score is higher, refinancing could lead to a lower interest rate.
High-interest rates could be leading to the consumer paying higher monthly payments for their loan or having a longer loan term. When shopping for a new car, consumers can use sites like Carzing to find all their financing options and compare interest rates.