Should I Pay Off My Car Loan Early?
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Yes, you should consider paying off your car loan early — when it makes sense. If you receive a windfall, such as a tax refund or a work bonus, you could pay part or all of the remaining auto loan. Or you could put more toward the minimum each month.
But it may not always be the right choice. Perhaps you have credit card debt with a higher interest rate or other priority obligations. We’ll highlight the pros and cons of paying off your car loan early.
Advantages of paying off a car loan early
Pro No. 1: You save money
Making a lump-sum payment reduces the amount owed on your auto loan. Say you borrowed a $20,000 loan with a five-year term and a 4.55% APR (interest rate plus fees), so you’re paying $373 a month. You’ve just received a work bonus, so you can put $1,000 or $3,000 toward your loan as a lump sum. This chart can give you a better sense of how long it’ll take to pay off a car loan with extra payments.
|Paying Extra on a Car Loan: Lump Sum|
|Original||After extra $1,000 payment||After extra $3,000 payment|
|Payoff date||April 2025||January 2025||June 2024|
|Payoff date savings||–||3 months||10 months|
|Total paid savings||–||$249||$704|
The concept remains the same if you decide to pay more than the minimum each month. Let’s take that same scenario of a $20,000 loan, a five-year term and a 4.55% APR. But this time, let’s assume you have enough money to add $50 or $100 monthly toward your auto loan payments.
|Paying Extra on a Car Loan: Monthly|
|Original||Extra $50 a month||Extra $100 a month|
|Time||5 years||4 years, 5 months||3 years, 11 months|
|Time savings||–||7 months||13 months|
|Total paid savings||–||$320||$563|
Keep in mind these only work if you have a simple interest loan rather than a precomputed interest loan. Breaking it down:
- Simple interest loan: The interest is calculated each month on the unpaid balance. Paying ahead can save interest.
- Precomputed interest loan: The interest is computed at the beginning of the loan term. There’s no benefit from an interest perspective to paying off your auto loan early.
Pro No. 2: You can take ownership sooner
If you’d like to sell or trade in your car, you can do that sooner by paying it off. That way, if you trade it in or sell it outright, you won’t risk potentially being upside down on the vehicle, which means you owe more than it’s worth.
Pro No. 3: You improve your chance of getting a mortgage
Paying off your car loan may help you qualify for a mortgage, as your monthly obligations will be lower.
Mortgage lenders will look at your debt-to-income (DTI) ratio, which compares the amount you owe each month to your monthly earnings. Conventional lenders look for a ratio of 45% or less, though they may allow up to 50%, depending on your credit score and cash reserves.
Disadvantages of paying off a car loan early
Con No. 1: You potentially owe prepayment penalties
Lenders can opt to charge prepayment penalties if you pay off your car loan early. Some lenders may charge a separate prepayment penalty, while others could use a precomputed interest format so you’ll pay more in interest in the first part of the loan term.
The latter method of calculating interest is banned on loans longer than 61 months, according to federal code. Truth in Lending Act disclosures and the loan contract would tell you how the interest is calculated or if the loan has a prepayment penalty. Make sure to shop for lenders that won’t charge you for this.
Con No. 2: You have better options for your money
If you have a low auto loan APR — say, 2.9% — it may make sense to put your money to work elsewhere.
As of February 2020 data — the latest available — from the Federal Reserve:
- The average interest rate on a 60-month new auto loan is 5.15%
- The average interest rate on all credit card accounts is 15.09%
You could pay off higher-interest debt, such as a credit card balance or a student loan, or consider saving it in a retirement plan or another investment. You could also put it away for an emergency fund.
Con No. 3: You could face cash flow problems
Don’t put more money toward your car loan if it’ll make it harder for you to meet other obligations like rent or utilities. If you’re building an emergency fund to cover medical expenses or periods of unemployment, it could be smarter to sock away money for a rainy day.
How to pay off a car loan early
Before you attempt to pay off your car loan early, make sure you understand how your lender applies payments to your auto loan. Many lenders will first apply payments to the interest that has accrued since your last payment, and then to the principal. The same may apply to extra payments, unless you give specific instructions to apply it to the principal only.
If you make an extra payment that matches your monthly amount, a lender may just count that as the next payment rather than as an additional payment. You may be able to tell the lender in writing or online how you want extra payments applied. Extra payments may even have to be mailed to a different address than where you send your regular payments.
Here’s a look at some of the various extra payment options.
Option No. 1: Full lump-sum payment
Making this type of lump-sum payment means paying the principal on a car loan all at once. You can ask your lender to tell you the auto loan payoff amount, which is the loan balance plus remaining interest through the day you plan to make the final payment.
Option No. 2: Partial lump-sum payment
If you come into a stash of cash, you can pay several months’ worth and then resume the regular schedule. You’ll still reduce the time until the loan is paid in full — and the interest you owe. Look at your monthly statements or online account to keep track of the balance.
Option No. 3: Extra monthly payment
You can pay extra each month to shorten the term of the loan. There are different options:
- If you have a 72-month term, you can use our auto loan payment calculator to figure out what the payments would be for a 60-month loan. Whatever the difference, you could add that to your amount to finish off your loan early. This will give you some flexibility if your budget changes.
- Add a little extra each month depending on your monthly cash flow. One easy way is to round up — for instance, if your payment is $378, pay $400.
- Divide the payment amount (principal plus interest) by 12 and add that number to each monthly payment.
- You could make half payments every two weeks, so that you make a full extra payment over the course of the year. Just make sure the full payment is made by the due date.
FAQ: Paying off a car loan early
Is it good to pay off a car loan early?
Yes. You’ll pay less in interest, meaning your car will cost less overall. But make sure it’s the right financial decision for you, considering your other obligations. Refinancing may also be a good option if you need to change your car financing situation.
Does paying off a car loan early hurt your credit?
It can depend on your credit mix. If you have numerous credit accounts but your auto loan is your only installment account, your score could see a slight drop because your mix will be less diversified. And if you have high credit card balances or other revolving debt, it may be better to pay that off first, especially if your car loan has a low balance. Overall, your payment history is the most important factor in your credit score, so make sure your on-time payments record is unblemished.
Can you pay off a car loan early without penalty?
Generally speaking, yes. Prepayment penalties vary by lender, and the loan contract should specify if there are any penalties or special procedures for paying off the loan ahead of schedule.
What happens when you pay off a car loan?
You take ownership of the car from the lender. Depending on state regulations, you either receive from the lender a lien release or the title itself; if your state allowed you to hold your title, you would need to have the lien holder’s name taken off once the loan’s been paid in full. You can take the title or the lien release to the DMV to get a new title that’s solely in your name.
Can paying off my car loan early affect my car insurance costs?
Lenders usually have minimum requirements for insurance coverage on your car. When you pay off the loan, you have more options. You can keep your coverage the same or decide to reduce it, by dropping collision or comprehensive coverage, for example. Make sure you follow the requirements for your state.
If my lender offers a skip-a-payment feature, should I consider it?
It may make sense if you have no other options, but you’re not really skipping a payment. Instead, you’re just delaying it — interest still accrues, and the payment is added to the end of the loan.