The Pros and Cons to Paying Off Your Car Loan Early

FT Contributor  | 

The thought of paying off a car loan is naturally alluring. However, at times it actually makes sense to hold off on doing so. Each individual scenario has to be taken into consideration, with your own financial goals, habits, and behaviors factoring into the mix.

We’ve gone ahead and gathered some of the most important pros and cons to keep in mind when considering paying off your car loan early.

Advantages of Paying Off Your Car Loan Early

Let’s begin with three of the most common advantages that come with paying off your car loan early.

Save on Interest

A loan can be split into two parts: principal and interest. The former is the amount of money you borrowed from a bank or other financial institution. The latter is the extra money that the financial institution charges if you can’t pay the entire principal balance back within a certain period of time.

Interest is charged over time, which means paying off your car loan early can save you significant amounts of money that would have eventually been paid in interest.

Financial Freedom

It’s hard to undersell the pure, unadulterated feeling of financial freedom. The ability to know you don’t owe anyone anything and that your car really is your car is a great benefit of paying off your loan ahead of time.

It also can free up extra cash to be reallocated towards anything from vacations to a house, emergency funds, or even other debt payments.

Lower Debt-to-Income Ratio

Your debt-to-income ratio is a critical factor when it comes to your credit score. The more debt you have, particularly when compared to your income, the lower your credit score is likely to be.

While there are plenty of other factors that go into your credit score, lowering your overall debt can be a great way to boost your score and help you get lower interest rates if you need to make bigger purchases that are dependent on your credit.

Disadvantages to Paying Off Your Car Loan Early

While the advantages stated above are fairly common knowledge, there are a few less-well-known disadvantages that should also be kept in mind when paying off a car loan early.

Early Payment Penalties

A common lender strategy is to include a condition on a loan that allows them to charge you an early payment penalty if you choose to pay early. While this isn’t always the case, when they are a factor, early payment penalties can impact the financial benefit of paying off your loan early.

In addition, penalties can often be disguised in the form of agreements for the borrower to pay back all interest on the loan before anything can be applied to the principal. The size of a penalty can vary depending on the loan and even the state in which the loan was issued (direct penalties are only allowed in 36 states). You’re going to want to look for any potential penalties on your loan in order to see if they factor into your situation.

Nevertheless, it should be pointed out that even with early payment penalties, it’s often still worth calculating the interest you’ll pay over the course of a loan from start to finish. At times, even with the penalty, it’s still worth paying things off and closing the account.

Getting Rid of a Low Interest Rate

When it comes to debt, car loans are often on the lower end of the interest spectrum. In other words, you may not want to prioritize paying off your car loan if you have other loans of greater concern.

A credit card, for instance, will almost certainly have a much higher interest rate and should be paid off before a car loan is considered. This form of debt repayment, known as the avalanche method, is often an excellent reason to defer any extra payments on your car loan.

Missing Opportunity to Build Credit

A good credit score costs money. No, you can’t literally pay for one, but a healthy score does require maintaining reasonable levels of debt over a long period of time. While you can build credit with various forms of debt, a car loan is an easy, low-interest way to build your credit by showing potential lenders that you can handle debt appropriately. If you pay it off early, you’ll miss out on the opportunity to build your credit over the long term.

How to Pay Off Your Car Loan Faster

If you do decide that paying off your loan is the right choice, here are a few tips for how to pay off a car loan faster.

Make a Larger Payment

An easy way to pay off your car loan quickly is to simply increase the amount that you pay towards it each month. Go over your personal budget and consider allocating a larger monthly amount towards your car.

If you do choose to do this, remember that the extra money that goes towards your principal does not count towards your next month’s payment. For instance, if you owe $250 per month and you pay $350 one month, you still owe the full $250 the next month. The extra $100 you paid will simply chip away at the total principal that you still owe on the loan.

Never Skip Payments

Skipping loan payments is always a bad idea. Not only can it hurt your credit, but it also lengthens the amount of time you’ll be in debt, as every skipped payment will ultimately be tacked onto the end of the loan, and you’ll pay more in interest. To put it simply: never skip a payment.

Refinance Your Loan

Finally, consider refinancing your car loan. You may have locked in your loan during a period where interest rates were higher than they are now. If this is the case, consider shopping around for a good refinancing option that will lower your interest rate and thus reduce the overall amount of interest that you ultimately pay.

If you decide to refinance, you’re going to need to gather up your loan documentation, check that you have a good credit score, and then apply in order to get some quotes. Compare these with your current loan’s terms and consider whether or not to make the switch.


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This post was updated November 26, 2019. It was originally published November 26, 2019.