Should I Pay Off My Car Loan Early, and How Will That Affect My Credit?

Ben Allen
car loan

Many myths exist in the world of credit surrounding ways you might destroy your credit score. Myths like: regularly checking your credit score hurts your credit (soft inquiries don’t,) only use credit cards for emergencies (use them more regularly and pay the balance off on time,) and paying off an old debt gets it removed from your credit report (it won’t).

The myth we’ll be debunking today though is that paying off your car loan early might hurt your credit. In short, doing this won’t hurt your credit.

It’s a pretty normal thing to not really understand what goes into a credit score, and what it means to “build credit.” People are often afraid to do anything that involves messing with their credit in fear they will ruin their credit score. It’s completely reasonable, as many high schools don’t teach a basic understanding of credit to their students, and many parents don’t understand it themselves.

It’s important to know that making regular payments on debts (and paying off your credit cards on time) are important to building your credit and paying off your car early does remove that activity off of your credit reports. If your car payment is the only credit activity on your credit report, it might be detrimental to lose that regular payment.

Table of Contents

What Happens When You Pay Off a Car Loan Early?

Good things happen when you pay off a car loan early, both in terms of your credit score and your overall finances. The first and largest benefit from paying off a loan early, is losing the debt. The sooner you pay off a loan, the less money you end up paying in interest. It frees up monthly income to go towards other expenses or into savings. For this reason, it’s always worth paying off debts early if you can.

Eliminating debt can also help boost your credit score. One factor that goes into your credit score is your history with credit and loans, and showing you’ve successfully paid off a loan is a positive signal that you are trustworthy. Eliminating a major debt reduces your overall credit utilization ratio, making you look less dependent on credit to make ends meet — definitely a positive signal to the credit bureaus.

The routine, incremental payments are also a positive signal, but making that final payment means an end to this signal. That doesn’t hurt your credit in any way — it just means lenders and credit rating agencies have one less insight into your financial behavior. While you’ve lost a source of regular positive points to your credit report, that shouldn’t dissuade from paying it off early. Instead, replace it with a form of revolving credit, like a credit card you can regularly use. Not only will you keep building credit, but you can reap extra benefits from the right credit card for your life.

How to Pay Off Your Car Loan Early

So now you know that paying off your car early won’t destroy your credit score, so how do you go about doing it? Well, it means putting more money into the loan regularly than the minimum required amount. Your minimum payment isn’t designed to help you pay the loan off quickly; rather, it is intended to maximize the amount you pay in interest. Anything you can do to change this will help you eliminate the debt and cut down the interest fees you pay.

Pay More than the Monthly Minimum

If you make a habit of increasing how much you pay every month, then you can shorten how long your loan is in a predictable time. Instead of paying $200 a month, by paying $400 a month, you cut your loan time in half.

This method might require some personal sacrifice in able to have the extra funds available. Make adjustments to your budget and find areas where you can decrease spending in order to put more money towards your loan. Just remember anything you can pay above the minimum will bring your payoff date a little closer. The more you pay above the minimum (and the more routinely you pay above the minimum) the faster you’ll pay off the loan.

Make Bi-Monthly Payments

If you get paid twice a month, you could choose to make two payments a month (instead of one larger payment) and delegate a portion of every paycheck to your loan. Again, doing this will get you on track to pay off your loan in practically half the time, or at least split up a larger bill into more affordable chunks.

Putting Extra Cash to the Loan

Gifts for holidays and birthdays, tax returns, inheritances, lotteries, prizes and more can all go towards paying off your car early. While it’s not as fun as treating yourself to something nice, that extra money can help lower your loan, especially if you get a good chunk of money for free. Even a couple hundred dollars here and there can do a lot to shortening your loan time, because it eliminates interest early.

Pay Extra Principal Each Month If Possible

Some loans will let you decide where the extra money you pay every month can go, and if you have the option, put that money towards paying your principal. That will decrease the amount of interest you have to pay later along with shortening you loan length. Some “interest only” loans will require you to pay an amount equal to the interest, meaning anything more than the minimum applies to the principal. Other loans may split your monthly payments between interest and principal. Whatever your situation, get the details straight so you can elect to pay down more principal every month.

Subprime Loans: Beware of Extra Fees

If you have bad credit and had to get a subprime car loan, there might be restrictions to paying off your loan early. Some loans have extra fees you must pay if you want to pay off your loan early, a major downside to getting out early. The idea is that paying a loan off early eliminates interest, reducing the income lenders make from you. An early payment fee ensures the lender still makes money from the loan even if you pay it off early. Before you start making extra payments, check with your lender to see if you will violate any part of your loan. Generally, early payment fees are still cheaper in the long run than interest, but it is worth double-checking to be certain.

Paying Off Your Loan Early, It’s a Good Idea

As long as you are able to keep up on all your other expenses and bills, paying off your car early is a great plan. You’ll take a financial burden off your back, freeing up money for other wants or needs. Additionally, you can continue to build your credit if you utilize credit cards intelligently. Unless you have a subprime loan, there really is no downside to paying off your loan early.

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