Should You Pay Off Your Car Loan Early? Or Is It Smarter to Wait?

Is it better to pay off your car loan in full or make monthly payments? This is a question that many car owners grapple with. While there are pros and cons to both approaches the answer ultimately depends on your individual financial situation and goals.

In this article, we’ll delve into the key factors to consider when making this decision. We’ll also explore the potential benefits and drawbacks of paying off your car loan early, helping you determine the best course of action for your unique circumstances.

Let’s dive in!

When Does Paying Off a Car Loan Early Make Sense?

There are several scenarios where paying off your car loan early could be a wise financial move. Consider these situations:

• You don’t have higher-interest debt and want to free up the cash for other financial goals.
• The auto loan has a higher interest rate than what you could earn by investing.
• You’re hoping to buy a home soon and want to lower your debt-to-income ratio.
• You recently received a windfall and have enough cash in reserves for emergencies.
• You want to build your savings account faster to have funds available for business ideas or other investments that foster financial freedom.
• You want to avoid having negative equity or being upside-down on your auto loan.
• You’re debt-averse, and it’s an important step for you in obtaining financial security.

If any of these situations apply to you, it might be wise to pay off your auto loan early.

Benefits of Paying Off a Car Loan Early

If you can manage it, paying off your car loan in full ahead of schedule can offer several significant benefits. Let’s explore some of the key advantages:

1. Save Money on Interest:

The more money you add to your payments and the higher your loan amount, the more you can save. Interest is typically spread out over the loan term. You’ll pay less interest by paying off your loan early since the lender will have less time to collect interest from you.

Even an extra payment here and there can make a difference. That extra amount should go directly toward the principal, especially if you specify that intention when you make your payment.

To determine how much you can save on your loan by making extra monthly payments or a single, large payment, use an auto loan early payoff calculator.

2. Take Ownership Sooner:

Your lender technically owns your vehicle until you pay off your car loan. Taking ownership of the vehicle means you’ll get the title in your name. It also means you will have more options if you plan to sell the car or trade it in.

You might be able to lower your insurance costs by choosing basic coverage if your lender mandated minimum insurance coverage. You will be in charge of deciding whether to maintain insurance coverage or change the amount if you buy the car outright. But if you can’t afford to replace your car in the event of an accident, it’s a good idea to hold onto the protection.

3. Less Risk of Being Upside-Down:

Sometimes cars depreciate faster than the payoff schedule of an auto loan. This is especially true if you have a long repayment term or a high interest rate.

It can be difficult to be upside-down on a loan or to owe more on an automobile than it is worth. If you try to trade it in, sell it, or have it totaled, you might encounter issues. In every case, you might have to pay the difference to your lender all at once, though most will let you roll it over into a new loan if you trade in the car.

4. Improve Your Debt-to-Income Ratio:

The percentage of your gross monthly income that is allocated to debt repayments is known as your debt-to-income ratio. It helps lenders determine how much you can afford to borrow. The higher your DTI, the riskier you look as a borrower.

Paying off your car early eliminates your auto loan from the equation. Naturally, your DTI will be lower, allowing you to apply for other types of credit. Additionally, it increases your chances of getting a better interest rate on a credit card debt consolidation or refinancing other loans.

5. Free Up Money for Other Expenses:

The average monthly payment on a new car was $738 in the third quarter of 2024, according to a report by Experian.

Paying off your car loan is a big opportunity to progress on other financial goals. If you keep the car you have and don’t take out another loan, you can put that money toward vacation savings, retirement funds, or other debt.

And even if you bought used, dropping that $532 average payment could still make a significant difference in your budget.

Disadvantages of Paying Off a Car Loan Early

While there are pros to accelerating your auto loan payments, there are also some potential downsides to keep in mind.

1. Prepayment Penalties:

Depending on your lender, paying off your loan early can result in additional fees. Some lenders charge a penalty for paying off a car loan early or making extra payments. Check your loan contract to see if your lender has one.

If your lender does charge a prepayment penalty, compare the cost to the potential savings you might get from accelerating your payoff schedule. If it’s too expensive, just continue paying down your loan on time — and put your extra money toward something else.

2. Lower Credit Score:

By ceasing your payments on a loan because you’ve paid it off, your streak of positive payment history will end. Additionally, your credit mix could be affected since credit bureaus like to see both installment loans, like auto loans, and credit lines, like credit cards.

Don’t let the fear of your credit score lowering hold you back from paying off your auto loan early, though. This potential dip is usually small and temporary, and if you continue to manage your credit accounts responsibly, it shouldn’t be an issue.

3. Money Better Spent Elsewhere:

If you have higher-interest debt, you may be better off focusing your efforts on those loans or credit cards first. That’s especially the case with credit cards, certain personal loans, and short-term debt.

Even if you don’t have high-interest debt, your money may be more effective if put toward retirement, a Health Savings Account, or some other tax-advantaged financial account. The same may go for general investing if your auto loan interest rate is low.

4. May Not Fit in Your Overall Budget:

If your budget is tight, it may be impossible to find any extra cash you can put toward your auto loan payment every month. Even if you can cut back in other areas, other areas of your financial life (such as high-interest debt, retirement, and emergency fund) may be more important.

Before deciding to pay off your loan ahead of time, take the time to look at your budget and make sure it won’t place you in an even more precarious situation.

How to Pay Off a Car Loan Early

Depending on how much money you have on hand, there are three ways you can work toward paying off your car loan ahead of schedule.

1. Pay It Off in Full:

If you received a big bonus at work or a tax refund, or you have money saved up, you may want to make one lump-sum payment to pay off your car loan in full.

To do so, learn the 10-day payoff amount, which includes interest that’s accrued since your last monthly payment. Then send a check to the lender or make the payment online to bring the balance to $0.

2. Pay It Off in a Partial Lump Sum:

If you don’t quite have enough to pay off the balance in full, you may make a large payment to pay down a big chunk of it. This won’t reduce your monthly payment, but it can significantly cut down on how long you’ll be in debt. And since it will go toward the principal, you’ll wind up paying less interest overall.

3. Increase Your Monthly Payment:

If you don’t have a large amount of cash you can put toward your auto loan, consider making larger payments each month instead. You can decide how much extra you want to pay. Even a small amount can save you money and time.

The Bottom Line

Paying off a car loan early can save you money — provided the lender doesn’t assess too large a prepayment penalty and you don’t have other high-interest debt. Even a few extra payments can go a long way to reducing your costs.

Before rushing to repay your auto loan, run the numbers to determine if it makes financial sense or if you should apply extra funds elsewhere. Early payoff is not the only route to lower costs. Refinancing your current loan can help you secure a manageable monthly payment.

The key to success is to keep your financial situation and goals in mind as you weigh the benefits and drawbacks to determine the best strategy for you.