Paying off a car loan early can be a great idea. Sometimes it might make sense, and other times there are better ways to spend or save any extra money. Like all major financial decisions, you may want to discuss with a financial professional and weigh the pros and cons of paying off a car loan early before jumping in.
Can you pay off a car loan early?
It is possible to pay off your car loan early but check your financing documents first to see if there is a penalty for pre-paying your loan.
Pay it all with a lump-sum payment
The first option is to pay the remaining balance of the loan at one time in one lump-sum payment. If you’re interested in this option, you can find out the remaining cost of your loan as well as any additional fees that may come with paying early by contacting your lender.
Pay a little extra each month
Another option is to pay a little bit extra every month by rounding up the payments to a higher number, say to the nearest $100. For example, if your car payment is currently $275 per month, you can round it up to $300 and pay an extra $25 per month. This can take longer than making one lump sum, but it could be a good choice if you only have a bit of extra income a month to spare for paying off the car loan.
Make a payment every two weeks
Submitting payments every two weeks on your vehicle instead of monthly can also help you pay off the loan a little earlier. By paying half of your monthly payment every two weeks, you end up making a total of 26 payments per year, which is equivalent to making 13 monthly payments in one year rather than 12. Contact your lender to make sure this is an option and for their assistance in setting it up.
What are the advantages of paying off a car loan early?
If you’re wondering whether you should pay off your car loan early, you may have several reasons to say yes.
The most obvious reason you might want to consider paying off a loan early is that it saves you money on the amount of interest you pay. It’s important to note that this only applies if you are paying a simple and not precomputed interest rate. A simple interest rate is calculated monthly based on what you still owe, meaning if you pay off your loan earlier, you won’t have to pay the interest that would have accrued over the remainder of your loan.
A precomputed rate, on the other hand, is determined at the beginning of your contract and remains a fixed amount for the entirety of your loan, so it’s likely you’d still be on the hook for that amount whether you paid the loan off early or not. You can use an online calculator to get estimated rates and monthly payments on financing.
More money for other expenses
What happens if you pay off your car loan early? You could potentially free up money in your monthly budget, meaning you have more room to spend on other debts or necessities. You could even save the extra cash for a rainy day.
Avoid being “upside-down”
It’s not uncommon for someone to owe more on a car than it’s worth. This is what’s known as being “upside-down” on a car loan.
Being upside-down on your loan is a potentially risky situation. If you were in an accident and totaled the car while you're upside down on your loan, you’d have to pay back the lender the worth of the vehicle plus the negative equity. Paying off your car loan early could help mitigate this risk.
Lower debt-to-income ratio
A debt-to-income ratio is the amount of money you make in a given period compared to the amount you owe in debt. Lowering this ratio may improve your credit, help you get approved for other loans (like a home mortgage), and help you qualify for lower interest rates.
What are the disadvantages of paying off a car loan early?
Some lenders charge a penalty for paying off a car loan early. The lender makes money from the interest you pay on your loan each month. Repaying a loan early usually means you won’t pay any more interest, but there could be an early prepayment fee.
The cost of those fees may be more than the interest you’ll pay over the rest of the loan. If that’s the case, it makes more sense to keep making your regular monthly payments instead of paying the loan off early. Check your financing documents or talk to your lender to see if there are prepayment penalties.
You may not want to pay off your car loan early if it’s going to put you in a precarious financial situation. Depleting your savings account or making larger monthly payments than you can afford may help you pay off this particular debt faster, but it could make it difficult to cover surprise expenses later.
You should only pursue paying off your car loan early if it doesn’t add unnecessary stress to your finances.