Making installment payments on a dealer-financed vehicle or personal loan to buy a car. can tie up several hundred dollars a month. Paying off your loan early has its benefits, like freeing up those funds for other uses, like savings, investments, and recreation. But there are also some drawbacks to an early payoff that you should know about. In this article, we’ll dig into the advantages and disadvantages of paying off a car loan early.
Pros of Paying Off a Car Loan Early
Eliminating your monthly car payment is a big deal because you can use that money for so many other things. There’s no need to elaborate on that further. Below are some other benefits of paying off a car loan early:
- Save on Total Interest Payments: You’ll pay interest throughout the loan term. Paying the loan off early reduces the total amount of interest you need to pay. That could add up to significant savings.
- Lower Debt-to-Income Ratio: Lenders look at your debt-to-income ratio (DTI) whenever you apply for a loan or credit card. Paying off a car loan early lowers DTI and improves the chances of getting approved for new credit in the future.
- Avoid Going Upside Down: Cars depreciate over time, so you could be at risk of going “upside down” if you stretch out your car loan too long. That means the car will be worth less than the remaining loan balance.
- Owning Your Car Outright: Lenders generally keep a lien on the car for as long as there’s an outstanding balance on the car loan. Paying the loan early means you’ll own your vehicle outright sooner than anticipated.
Cons of Paying Off a Car Loan Early
Discharging debt is typically viewed as a good thing, but there are some drawbacks to paying off a car loan early. It’s important to understand these before initiating the payoff.
- Early Repayment Penalties: Lenders generate income with interest payments and fees on your loan. Paying the loan off early means they’ll take a loss, so they’ll sometimes charge an early repayment penalty. Check your loan agreement to see if there’s a clause in the contract. Make sure the savings of early repayment exceed the penalty.
- Funds Could Be Used Elsewhere: The interest rates on car loans are generally lower than credit card interest rates, so paying off the loan first might not be the most cost-effective move. If you have any outstanding credit card bills, paying those off first may be more beneficial to save you more money.
- Credit Score Impact: Closing a credit account, even if it’s a payoff, can lower your credit score for a few months. It should recover quickly, but there will be an impact. So, you want to keep this in mind if you’re looking to make another large purchase that would require a credit pull.
How to Pay Off a Car Loan Early
Paying off a car loan early doesn’t necessarily mean paying the outstanding balance in one lump sum. That’s certainly one way to do it, but you could also try adding a little extra to each payment every month or making double payments each month to cut the loan term in half. Either of these will accomplish your goal of eliminating the loan debt faster.
Another way to pay the car loan off early is to split the car note into biweekly payments. This adds an additional month’s payment to the loan each year because you’ll make twenty-six half payments instead of twelve full ones. That will help you pay off the loan faster.
The Bottom Line
There are several benefits to paying off a car loan early and a few drawbacks. The benefits include savings on total interest payments, lowering your debt-to-income ratio, avoiding an “upside-down” scenario, and taking full ownership of your car. The drawbacks are early repayment penalties, leaving higher-interest accounts unpaid, and negatively impacting your credit score. Consider all these factors before paying off your car loan.
In the end, the ultimate decision is up to you and based on your needs and financial goals. So be sure to read the fine print on your loan and calculate what works best with your budget before making your final decision.
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