Okay I will demonstrate this with simple hypothetical examples, Person A and Person B.
Person A and B each buy the exact same model of car. They put down the same size down payment. They get the exact same car loan with the same terms and interest rate. They each buy gap insurance* for his/her vehicle. In the end they end up paying $30,000 for their cars.
* NOTE: For those that do not know, "gap insurance" is used to bridge the gap between the car's value and the (higher) balance that is still owed on the car loan. Most cars' values will depreciate drastically when the car is driven off the dealership lot, therefore people that do not put down a significantly large down payment will find themselves "upside-down," or owing more on the loan than the car's worth, for the first portion of their car loan. In the event of a major accident, "gap insurance" covers the difference between the high balance on the car loan and the car's decreased value.
Unfortunately, Person A and Person B end up totalling their cars some time later(let's say 1 yr). By this time, each car has depreciated in value to $20,000.
However, the way that Person A and Person B paid their car loans reflects how much money they've lost:
Person A: Paid only the minimum payments. In a year's time, he paid down the loan from $30,000 to $25,000. So he still owes more on the loan than the car's worth, but hey that's what gap insurance is for. His insurance company covers $20,000(car's current value) and the gap insurance covers the $5,000 that was remaining on the car loan, and Person A gets nothing. He has invested $5,000 into the car that is now lost.
Person B: Paid way above the minimum each and every month in an attempt to save money on the loan's interest, and because he knows it is unwise to carry large amounts of debt. He thought he was being "smart." In the same year's time, he paid down the loan from $30,000 to only $12,000. Basically he invested $18,000 into this car. When the car got totalled, he got paid $20,000(equivalent to the car's current value), of which $12,000 went to pay off the car loan and $8,000 went into his pockets. But subtract the $18,000 that he'd already "invested" into this now-defunct car, (8,000 - 18,000 = -10,000) and you'll see that he lost $10,000 in this car.
As you can see, Person B thought he was "smart" by paying down his car loan early...but in the end, he lost more money than Person A!
Now if Person B didn't get into the accident and he kept the car for a long time(10yrs+, or even better if he kept onto it for years until it reached "classic car" status, at which point the car's value would start increasing if is maintained nicely), I would say that he was better off paying off the car loan early. But it sucks that all was lost when his car got totalled.
I am very similar to Person B with the way I conscientiously pay my car loan way ahead of schedule. I was thinking this horrifying scenario last night as I was desperately and frantically trying to navigate home in the icestorm. I guess the moral of the story is, be careful and avoid accidents as best you can. For example, on most days I purposely avoid driving in the snow because the last thing I want to do is total a car that I've already paid off most of the loan in such a short time.
The other moral of the story is, perhaps it isn't worth scrimping and sacrificing so much just for the sake of paying off a car loan. If you can afford to make an extra payment each month, great; if not, it might not be worth it at the sacrifice of starting a savings account or getting that cavity filled.
What do you guys think? My roommate and I were discussing this hypothetical last night after my nightmare drive home LOL.


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