The decision to pay off a car loan early depends on your budget, the interest rate on your loan, and your other financial goals.
In general, you should pay off your car loan early if you don’t have other high-interest debt or pressing expenses to worry about. however, if that money could be better spent elsewhere, paying off your car loan early may not be the best option.
Reading: Pay off car loan or invest
when does it make sense to pay off a car loan early?
There are a few scenarios where it might make sense to focus your efforts on eliminating your auto loan debt. Here are some qualifiers that can help you decide if it makes sense for your finances:
- You don’t have higher-interest debt and want to free up cash for other financial goals.
- The car loan carries a higher interest rate than you could earn by investing.
- expects to buy a house soon and wants to reduce your dti.
- you recently received a windfall and have enough cash in emergency reserves.
- you are generally reluctant to debt, and is an important step for you in gaining financial security.
benefits of paying off a car loan early
If you can manage it, paying off a car loan in full ahead of schedule can have big benefits.
save money on interest
Because interest is generally spread out over the term of the loan, you’ll pay less interest when you pay off your loan early. but even an extra payment here and there can make a difference in savings. that extra amount should go directly to principal, especially if you specify that intent when you make your payment.
Use an auto loan payoff calculator to find out how much you can save with additional monthly payments or a large balloon payment on your loan.
Key takeaway: The more money you add to your payments and the larger your loan amount, the more you can save.
take possession before
Until you pay off your car loan in full, your lender technically owns your vehicle. taking possession of the vehicle means that you will get the title in your name. it also means you’ll have more options if you plan to sell the vehicle or trade it in to a dealer.
If your lender requires minimal insurance coverage, you could potentially lower your insurance costs by opting for basic coverage. Owning the vehicle outright will give you control over whether to continue insurance coverage or adjust levels. but it’s a good idea to retain protection if you can’t afford to replace your vehicle in the event of an accident.
Key takeaway: Owning your vehicle means it’s easier to sell and can potentially lower insurance costs.
less risk of being upside down
Autos sometimes depreciate faster than an auto loan’s amortization schedule. this is especially true if you have a long payment term or a high interest rate.
Being upside down on a loan or owing more than the car is worth is a tricky situation. you may have problems if you try to sell or trade the vehicle or if the vehicle is totaled. In all cases, you may need to pay your lender the discrepancy in a lump sum, although most lenders will allow you to transfer the amount to your new loan if you trade in the vehicle.
Key takeaway: Understand how your vehicle will depreciate and avoid owing more money on your loan than the car is worth.
improve your debt-to-income ratio
Your debt-to-income (DTI) ratio is the percentage of your gross monthly income that goes toward paying down debt. it is an important factor lenders use to determine how much you can afford to borrow. The higher your dti, the more risky you appear as a borrower.
Paying off your car early takes your car loan out of the equation. Your DTI will naturally be lower, which opens you up to other forms of credit. It also helps improve your chances of refinancing other loans or consolidating credit card debt at a lower rate.
Key takeaway: A lower DTI can help you qualify for better credit in the future.
free up money for other expenses
The average monthly payment for a new car is $648, according to a report from Experian. Paying off your car loan early presents an important opportunity to make progress on other financial goals. If you keep the car you have and don’t take out another loan, you can put that money toward vacation savings, retirement funds, or other debt. And even if you bought used, ending up with the average payment of $503 could still make a significant difference in your budget.
Key takeaway: Build extra space into your budget with several hundred dollars each month.
disadvantages of paying off a car loan early
Prepayment penalties and less open accounts can take a toll on your finances. So while there are several benefits to speeding up your auto loan payments, there are also some potential drawbacks to be aware of.
fines for advance payment
Some lenders charge a penalty for paying off a car loan early or for making extra payments. check your loan agreement to see if your lender has one.
If your lender charges a prepayment penalty, compare the cost with the potential savings you could realize by accelerating your payment schedule. if it’s too expensive, keep paying your loan on time and put your extra money elsewhere.
lowest credit score
If you stop making payments on a loan because you already paid it off, your streak of positive payment history will end. Plus, your credit mix could be affected, since the credit bureaus like to look at both installment loans, like auto loans, and lines of credit, like credit cards.
However, don’t let the fear of your credit score drop keep you from paying off your auto loan early. This potential drop is usually small and temporary, and if you continue to manage your credit accounts responsibly, it shouldn’t be a problem.
money better spent elsewhere
If you have higher-interest debt, you’re better off focusing your efforts on those loans or credit cards first. that’s especially the case with credit cards, certain personal loans, and short-term debt.
Even if you don’t have high-interest debt, that money could be used more effectively by putting it toward retirement, a health savings account, or some other tax-advantaged financial account. The same can apply to general investments if your auto loan interest rate is low.
may not fit your overall budget
If your budget is tight, it may be impossible to find extra money to put towards your auto loan payment each month. Even if you can cut back in other areas, the focus can return to other areas of your financial life that need more attention, like high-interest debt, retirement, and your emergency fund.
Before you decide to pay off your loan early, take the time to review your budget and make sure you won’t put yourself in an even more precarious situation.
how to pay off a car loan early
Depending on how much money you have available, there are three ways you can work to pay off your car loan sooner than expected.
pay it in full
If you received a big bonus at work, a tax refund, or have money saved, you may want to make a lump sum payment to pay off your car loan in full. To do this, get the 10-day payment amount, which includes interest accrued since your last monthly payment. then send a check to the lender or make the payment online to bring the balance to $0.
pay it in a partial lump sum
If you don’t have enough to pay off the balance in full, you can make a large payment to pay off a large portion. This won’t lower your monthly payment, but it can significantly reduce the length of time you’ll be in debt. And since it’s going toward principal, you’ll end up paying less interest overall.
increase your monthly payment
If you don’t have a lot of cash to put toward your auto loan, consider making extra payments each month. you can decide how much extra you want to pay, and even a small amount can save you money and time.
the end result
Paying off a car loan early can save you money, as long as there are no extra fees and you don’t have other debt. even a few extra payments can go a long way toward lowering your costs. Consider your financial situation, monthly goals, and cost of debt, and do your research to determine the best strategy for you.
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