As lenders make auto loans accessible to more borrowers, loan terms can be extended up to 96 months, which can keep borrowers paying off a car for up to eight years! A long-term loan can carry a significant amount of interest, so paying it off early can save money and eliminate a costly item from your monthly budget.
should you pay off your loan early?
It may seem like paying off your loan early is a good idea, but there are a few factors you’ll want to consider before deciding if it’s the right move for you.
determine your current balance and payment penalties
The first step in deciding whether to pay off your auto loan faster is to view the details of your loan. Some lenders make it difficult to prepay auto loans because they will receive less interest payment.
If your lender allows prepayment, ask if there is a prepayment penalty, as a penalty could reduce the interest savings you would get.
Next, check your balance and make sure any extra payments are going toward the principal of the loan. Some financial institutions will automatically apply additional payments for interest or other fees, instead of reducing the principal, or will hold the funds as a credit toward your next payment. you may need to specify that the extra money is a “principal payment only,” so check with your lender first.
calculate how much you will save
After you’ve found out how much you owe and if your lender imposes prepayment penalties, use an auto loan calculator to determine how much you’ll save if you pay off your auto loan early. make sure the savings outweigh any prepayment penalties you may incur.
Even if your calculations show minimal savings for a loan prepayment, you may find other benefits that make it worthwhile. For example, eliminating your loan by paying it off early could help you boost your credit score and free up money in your monthly budget.
Consider how paying off a car loan early affects your credit
Paying off your car loan in full could help or hurt your credit, depending on certain factors.
when paying off a car loan helps your credit
Paying off your loan early can help your credit scores by improving your credit utilization ratio. the less debt you have, the more likely your scores will improve. Lenders prefer borrowers with a low credit utilization ratio, which is seen as a sign that you can manage repayments responsibly without exhausting your available credit.
Lenders also look at the amount of debt you owe compared to your income, or your debt-to-income ratio (DTI), as a way to assess your ability to obtain new loans. Having fewer debt payments, along with a completed installment loan and a history of paying on time, could work in your favor any time you want to apply for new financing, like a home mortgage.
When paying off a car loan hurts your credit
However, it could hurt your credit score if you don’t have another type of open installment loan. Lenders tend to view current credit accounts that are in good standing over closed credit accounts. And without another installment loan, like a mortgage, student loan, or personal loan, it will limit your credit mix, which is 10% of your FICO credit score.
On the other hand, your on-time payment history will remain on your credit reports for up to ten years, so excellent credit is still possible, even without open loan accounts. Plus, payment history makes up 35% of your FICO score. Even if your credit score drops slightly after paying off your car loan, it may be worth paying it off sooner if you have a high-interest loan. you can check your credit score here.
5 tips for paying off a car loan early
1. consider refinancing your current car loan
If your car loan came with a high interest rate or other monthly fees, refinancing your car loan could give you better terms and a lower payment, especially if your credit score has increased since you applied for the original loan (which likely if you’ve been making monthly payments in full and on time).
When considering refinancing options, keep in mind that your goal is to pay off the loan quickly. refinancing with a new 72-month loan is a relatively long time, it’s six years. instead, look for a shorter term and a lower interest rate. If you’re refinancing a long-term loan, consider paying more of the principal each month to pay off the loan early.
2. make biweekly payments
If you change your payment frequency to every two weeks, instead of once a month, you will make an additional payment every year.
Here’s how it works: There are 52 weeks in a year, which means not every month has only four weeks. in fact, some are a bit longer. That’s why people who get paid every two weeks actually get three paychecks in April and September. So if you pay 50% of your car note every two weeks, you will actually pay two additional half payments each year, adding up to one additional payment each year.
This technique will also lower your interest payments over the life of the loan, since you’re lowering your remaining balance at a faster rate.
3. round up your car loan payments
Another way to slightly increase your payment schedule is to round your payment to the nearest $50. For example, if you borrowed $13,000 at a 5% interest rate for 72 months, your monthly payment is $209. On a regular payment schedule, you’ll pay $2,074 in interest over the life of the loan.
If you round that payment up to $250, you’ll pay off the loan at least 13 months early and save at least $395 in interest.
4. review plugins
You may be delaying your loan payment by paying fees for additional items that were included in your original loan agreement. To identify these plugins, take a look at their documentation. Here are some examples of the items you can find:
- Guaranteed Asset Protection (Gap) Exemptions
- Service Contracts
- Extended Warranties
- Wheel and Tire Warranties
Some of these items may still be useful or even necessary, however others may be removed and as a result you may even get a partial refund or credit for some of the expenses you already covered. To see what steps you can take to cancel unwanted add-ons, contact your lender or dealer.
5. find extra money
Another way to pay off your debt faster, including a car loan, is to consistently put extra money toward your debt . If you can get extra money, here are some strategic ways to use it:
snowball (or avalanche) in your debt payments
With the snowball method, you make additional payments on your smaller debt until it is paid off. then apply the money you were putting toward that debt to your next largest debt and continue the pattern until you are debt free. this method can be a good option for people who need motivation to get started, as it results in faster payout of smaller bills.
The avalanche method also involves putting extra money on one debt at a time, only you’ll start with the debt with the highest interest first. this method is best for someone who wants to save the most money on interest charges while paying down debt.
The key to success with either method is to stick with it until your debt is paid off and resist taking on new debt during this period.
use tax refunds, bonuses and salary increases
Applying tax refunds, bonuses and pay raises to your car loan may seem painful now, but in the long run, paying off your car loan faster will free up your budget for more pleasurable expenses like vacations or dining out.
Applying pay raises to car loan payments is an especially effective method of paying off a car loan. Instead of increasing your expenses, arrange to pay the extra income toward your loan until the debt is paid off. Pay raises may not result in a big increase per paycheck, but over time they will help reduce your car loan balance more quickly.
earn extra income
If you can’t find extra money in your budget to pay off your car loan, try creative ways to come up with some extra money. that could include selling or renting personal items, or finding extra work. consider some of these options:
- rent a room in your house
- do yard work for friends and neighbors
- sell items online, such as old stereo, tools, jewelry or equipment of training. you could even list your second car on craigslist
- sit a house or take care of a pet
- take a temporary side job that includes tips, like ride-sharing services or restaurant work
- apply for a new job or talk to your boss about a promotion or raise
reduce extra expenses
Temporarily cutting other items out of your monthly budget can also free up cash for your car payment. Can you go without cable or decrease the data plan of your cell phone? Reducing your restaurant and entertainment budget or giving up brand-new clothing or other items for a year can make a big difference in paying off your car loan quickly.
If you’re not sure where to start, take a look at your most recent bank and credit card statements and make a note of every expense you can cancel, reduce or eliminate.
frequently asked questions about prepaying your car loan
how do i get out of a car loan?
There are several ways to get out of a car loan. you can pay it off, refinance, sell the car to an individual or a dealer, or trade in the car for a less expensive vehicle.
what happens when you pay for your car?
When you pay off the car, the lender will send you the title or a lien release statement.
In states where the lender holds the title until the loan is paid off, they will send you the title when you pay off the car, marked clear and clear of liens. In states where a person holds the title instead of the lender, the lender will send a lien release document, stating that the car no longer has a lien.
Is it better to pay the principal or interest on a car loan?
It is better to pay the principal. Principal is the fixed amount you borrowed to pay for the vehicle, but interest rates can change based on how much principal you still owe each month. By reducing principal early, you reduce the amount you have to pay in interest.