The financial institution where I have my car loan sent me a special holiday offer in the mail this week. They offered to let me skip a payment on my loan in the month of December without penalty so that I could use that money for Christmas instead. Is this a good idea? Let’s take a look.
(Today’s article is pretty heavy on the math. If your not into that sort of thing just skip to the end. There is a convenient TL/DNR section for you. TL/DNR stands for Too long. Did not read.)
How the skip a payment plan works
According to the letter from my financial institution, I didn’t have to pay my loan for one month. Instead, I just had to pay a fee of $20 which went to some kind of a holiday charity. Then my payments would start right up again in January.
The problem with this plan is that even though my payments take a month off, your bank or credit union won’t give you a month off from interest. Interest will keep on accruing just like normal. When you make January’s payment you will have to pay both December and January’s interest. The payment will be the same amount, but if you pay close attention you will see that the amount of your January payment that goes to principal is much lower than normal since it has to cover two months interest.
You might expect that since you skipped the December payment, that you have to make an extra payment at the end of your loan, which seems fair. That’s not completely true though. Not only will you have to make an extra payment at the end of your loan, but you will also have to make an additional smaller payment after that extra payment to cover that extra months worth of accrued interest.
Just how much will skipping a payment cost you?
Let’s look at some example numbers so you know just how much skipping a payment will cost you. Let’s say your car loan is a 5 year loan for $20,000 with an interest rate of 5% and a monthly payment of $377. These are all very average numbers for a car loan. Let’s say that the loan was taken out in July of this year.
In this example, in your November payment of $377, $79 went to pay the bank’s interest charges and $298 went to pay down the principal balance of your loan. Congratulations! Paying off almost $300 of debt a month is something to be proud of.
But when December comes if you skip that payment not only will your debt not go down by $300, but you also will still owe the bank $78 for December’s interest.
When you make January’s payment of $377, you will have to pay a whopping $157 in interest, which will only leave $220 to pay down principal in January. At this point you are not only down the $377 you didn’t pay in December, but you are actually down $399. That is $377 from the amount you didn’t pay plus an additional $2 interest on the principal you didn’t pay down in December you should have, plus the $20 payment for the fee to skip a payment.
At the end of the 5 year term you will have paid an extra $119 in addition to having an extra payment at the end. That $119 in extra payments you have to make is made of up $20 in the skip a payment fee, plus an additional $99 in interest.
So would you pay $119 for the privilege of using $377 for an extra month. Nope! That is not a deal at all.
What if you skip a payment every year?
But of course your loan company isn’t going to just offer this “deal” to you this year, they are going to offer it every December. Using the same numbers as above lets look at what happens to your 5 year loan of $20,000 if you only make 11 payments every year.
First of all, your $20/ year fee will add up to $100 over the five years. The interest will also add up as well. The extra interest from those five skipped payments will be mean an extra $298 in interest payments before all is said and done. That is a total of paying an extra $398 on your loan.
What about the length of your loan? Well, your 60 month loan will now take 67 months to pay off if you skip a payment once per year. That’s not a deal at all.
A better way to reduce your payments
If you really want to lower your car payments, I suggest you see if you can refinance your car loan to get a lower interest rate. This article tells you how to do it.
Don’t skip payments! It costs too much! An even better idea is to not pay for your car with a loan in the first place.
Photo from lendingmemo.com