Managing Auto Loan Debt
How to secure and manage an auto loan to avoid default and repossession.
With a few exceptions, you really need a car to live comfortably in most parts of the U.S. Public transportation options are often limited and large urban areas with sprawling suburbs usually mean long commutes to work.
Auto loans are also a good kind of debt to hold – they’re a traditional type of loan with fixed payments and a finite amount of debt to pay back. Add in the benefit of getting you the set of wheels you need to get around and you have a good debt that can be a positive part of your healthy financial outlook… as long as you obtain a loan that works for you and make sure you’re managing auto loan debt effectively.
The information below can help you manage your auto loan and use the debt payoff to your best advantage. If you’re having trouble managing debt within the limits of your budget, we can help. While auto loans can’t be consolidated, our certified credit counselors can help you find workarounds like credit card debt consolidation if you overall debt load is too much to handle. Call Consolidated Credit at or complete an online application to request a confidential debt and budget evaluation from a certified credit counselor free of charge.
Tip No. 1: Don’t buy more car than you can afford
The first step to a good auto loan debt management strategy is to get an auto loan that works for your budget. If you buy too much car for your budget, then chances are higher that you’ll have trouble down the road before you pay off the debt.
The average consumer spends about 11 percent of their monthly income on car payments and about 18 percent of their income on transportation costs as a whole. That extra 7 percent covers things like gas, maintenance, parking and tolls. If you apply for a loan on an expensive vehicle that will take up more than 11 percent of your income, then you may be at higher risk of facing issues with payoff.
You should also make sure that the total cost of your new vehicle doesn’t exceed what you can afford. If you buy your dream car because you can afford the payments but it only gets 12 miles to the gallon and you can’t afford the gas, then you’ll be stuck. Also keep in mind maintenance costs – foreign and exotic cars can be more expensive to repair.
Tip No. 2: Understand How Your Auto Loan Works
Auto loans are considered a secured, fixed debt.
- The “secured” part means that the loan requires collateral – i.e. the car itself. If you fail to pay the loan off, the dealer is within their right to repossess the vehicle.
- Having a “fixed” debt just means that the monthly payments are a set amount from one month to the next. This is also referred to as an “installment” debt.
As with any other loan, you apply for a loan amount that will cover the price of the car minus your down payment. The more you put down up front, the less debt you’ll have to worry about later. A larger down payment may also help you secure better terms on your loan.
The lender will check your credit and credit score to see if you qualify for a loan in that amount. Your credit score will also determine the interest rate you’ll pay. Higher interest means your car will cost more overall with interest charges. Interest will be applied every month you make payments, so the faster you pay off the loan the more affordable it will be overall. Auto loans typically run for 36, 48, 60 or 72 months.
A shorter-term loan means less interest paid over the life of the loan, but it also means higher monthly payments. Make sure to run the numbers to ensure you can afford whatever loan you choose to take out.
Tip No. 3: Consider automatic payments
This is where you set up payments to be automatically deducted from your bank account. Assuming you secure a loan you can afford and don’t run into financial distress, fix payment deductions each month should be easy to manage – just make sure you always have money in your account on the payment date.
In some cases, the lender will charge lower fees or may give you some other incentive for setting up automatic payments.
Tip No. 4: Refinance when possible
There are two good reasons to refinance an auto loan:
- Your financial situation has changed and you can’t comfortably afford the payments.
- You can qualify for a better interest rate.
In the first case, if you did your due diligence and made sure you could afford the loan initially, then the only reason you’d need to refi is if you have a change in your situation – loss of job, a pay cut or reduced hours at work, or something like a medical emergency that piles on extra debt on your plate.
If this happens, don’t wait to refinance! The longer you leave the loan as is and struggle, the more likely you’ll fall behind or miss payments. Even if you keep up with your auto loan, missed payments on your other debts may drag down your credit score. After a certain point, you may not qualify to refinance at all or the interest rate won’t be low enough to help. Refinancing immediately will ensure you can qualify for the best terms and rates possible.
In the second case, there are two ways you could be eligible for a better rate at a later time after you’ve already taken out the loan:
- Your credit score improves
- Auto rates are lower than when you purchased
Depending on how low your score is to start, taking steps to improve your credit score can lead to significantly better credit in as little as six months. So even with a 3-year loan, you can benefit from refinancing that early in. Just be aware that waiting longer to improve you score just a few points won’t typically lead to a major difference in your new loan, but a significant change in your credit score can have a big impact on total loan cost.
As for auto rates being lower, the rate you qualify for initially is based on your credit score, but also on the national rates available when you apply. If rates drop after you get your loan, then you may want to refinance even if you credit score is the same as when you applied. You can monitor rates available in your area through free websites like Bankrate.
Tip No. 5: Plan strategically around any introductory period
Often if you finance through the dealership, they may offer incentives to get you to apply, like 0% APR for a certain amount of time on the loan. So you may get a 72-month loan with 0% APR for the first 48 months.
First, be aware that although these offers are advertised like anyone can take advantage, you usually can only qualify if you have excellent credit. Only about 10 percent of consumers are usually creditworthy enough to get these terms. You should also be aware that the dealer may be less likely to haggle on price if they know they won’t be making any profits off the interest charges.
If you’re one of the lucky few and the deal is good for your budget, then make sure to plan strategically to pay off as much of the debt before interest gets applied. This saves you money, but it also ensures your payments don’t increase once the introductory period ends. Ideally, paying off the loan in-full means you don’t pay anything extra for your car even though you financed it.
Tip No. 6: Extra cash is usually better used on other debts
Unless you’re in a situation like the one mentioned above where you’re trying to pay off your auto loan before the introductory 0% APR period ends – or even so, in some cases – there are usually better debts on your plate to eliminate than your auto loan if you get some extra cash.
Whether it’s a salary increase or a cash windfall, if you have extra cash on hand to pay off debt, there should be other debts that you pay first before you pay off your auto loan. Car loans usually have rates less than 10 percent, while credit card debt usually has rates higher than 15 percent. In other words, your credit card balances cost more each month. Pay off debts with higher interest first, then if you still have extra cash you can focus on eliminating your auto loan.