Paying off your car loan before its term ends may be wise, especially if you have a high interest rate. If you’re looking to put debt in the rearview mirror, you may be wondering, “Should I pay off my car loan early?” But this tactic might not be the best choice if that money could be better spent elsewhere. Learn when it does (and doesn’t) make sense to pay off your car loan early.
Yo, car enthusiasts! Are you wondering if you should ditch your monthly payments and pay off your car loan early? It’s a question that plagues many drivers, and the answer isn’t always a simple yes or no.
But fear not, my friends! We’ve got your back. In this comprehensive guide, we’ll delve into the pros and cons of early car loan payoff, helping you decide if it’s the right move for you.
So, buckle up and let’s get rolling!
Who Should Consider Early Payoff?
If you’re rocking a high-interest rate, paying off your car loan early can be a major money saver. According to Experian, the average used car interest rate in Q1 2023 was a whopping 11.17%. Borrowers with less-than-stellar credit can expect even higher rates, averaging 21.32% for scores below 500.
If you receive a windfall—a bonus, inheritance, or winnings from the lottery, for example—applying that additional money to your auto loan might be a wise decision.
Planning a big purchase? Freeing up your monthly car payment can give you more breathing room to snag that dream vacation or invest in your future.
Income on the rise? Congrats on the raise! But beware of lifestyle creep. Instead, put that extra dough towards your car loan and crush your debt faster
Remember: When making extra payments, ensure they go towards the principal, not just interest.
Benefits of Early Payoff:
Save big on interest: This is the biggest perk. The longer your loan stretches, the more interest you cough up. Therefore, making an early payment, particularly with a lump sum, can result in substantial savings.
Own your vehicle: Your car is technically owned by the lender while you are still making payments. Pay it off, and you’ll receive the title, making it your baby.
Budgeting bliss: The average American car payment is a hefty $725 a month. Paying it off early frees up that cash for other goals, like home improvements or saving for your kids’ college.
Boost your DTI: Your debt-to-income ratio measures how much you owe versus how much you earn. Paying off your car loan lowers your debt load, improving your DTI. This can make it easier to secure future loans or credit cards.
Avoid the upside-down trap: Although used car prices have recently skyrocketed, the market is beginning to stabilize. You may be upside-down in your loan if you financed a used car at a price higher than its market value. Paying it off eliminates this risk.
Insurance flexibility: When financing a car, full coverage is usually mandatory. Leasing often requires even higher liability limits. You can lower your coverage after you buy your car outright and possibly save a lot of money.
Word of caution: Minimum coverage comes with risks. If you’re at fault in an accident without full coverage, you’ll pay out of pocket for repairs or replacements. The same goes for lowered liability if your damage or injuries exceed your policy limits.
Selling made simple: Selling a financed car can be a pain. You need access to the title, which means paying it off first. Owning your car outright makes selling a breeze.
Drawbacks of Early Payoff:
Prepayment penalties: Some lenders, especially those catering to bad credit, charge a fee for early payoff. This is called a prepayment penalty. Crunch the numbers and see if the penalty outweighs the benefits.
Credit score dip: Your credit score considers your credit mix. If you only have a car loan and close it early, your score might take a temporary hit. But don’t worry, as long as you keep paying other debts on time, it should bounce back quickly.
Better debt to pay off? There’s good debt and bad debt. Cars with large down payments and short loan terms are generally considered good debt due to lower interest rates. If your car loan falls into this category, focus on paying off high-interest bad debt like credit cards or payday loans first.
Financial strain: Depending on your situation, early payoff could cause hardship. If it depletes your savings, it’s better to build your emergency fund or tackle other debt first.
Strategies for Early Payoff:
Lump sum attack: This is best for those with a windfall or a strong dislike for debt. Call your lender for the payoff balance and say goodbye to your loan in one fell swoop.
Extra payment power: Can’t do a lump sum? No worries! Pay more than the minimum each month. Create a budget to determine how much extra you can safely manage.
Biweekly payments: This strategy can save you money. Instead of monthly payments, make payments every two weeks. This adds up to 13 payments a year, speeding up repayment and reducing interest. But, not all lenders allow biweekly payments, and it requires manual payments or setting up automatic bill pay.
Remember: Early payoff can be a smart move, but it’s not always the best choice. Weigh the pros and cons, consider your financial situation, and make the decision that’s right for you.
Happy driving, and may your financial journey be smooth!
Who should consider paying off their car loan early?
- If your interest rate is high: Experian data shows that the typical interest rate on a used car was 11. 17% in the first quarter of 2023. Low credit score borrowers should anticipate even higher interest rates, with an average of 21 32% for borrowers with scores below 500. Paying off your car loan early can save you a lot of money if your interest rate is high because you will have to pay less in interest.
- If you’ve been lucky enough to receive an unexpected windfall—such as an inheritance or bonus—you might want to consider applying it to your auto loan.
- If you want to make a large purchase, paying off your car can free up money that you can use for another expensive item or investment.
- If your income has increased recently, congratulations! However, watch out for the dreaded lifestyle creep – you could make good use of your pay increase by paying more than the minimum amount due on your car payment each month.
Make sure that any additional money you pay over the minimum amount owed on your auto loan goes toward the principal, not just the interest, if you choose to pay off your vehicle early.
Could see a temporary dip in your credit score
Your credit score is calculated using a number of factors, including your credit mix. Borrowers with more than one kind of debt typically have a better credit mix than those with just one or two types of debt.
Your credit score may suffer if you have just one auto loan and pay it off early because your credit mix will be different. Annoying? Yes. Fortunately, though, if you keep up with paying your other bills on time, your credit score ought to rise rather quickly.
Paying Off Car Loan Early | Principal vs Extra Payment Explained
FAQ
Is it worth paying off a car loan early?
What happens if I pay an extra $100 a month on my car loan?
Does it look good to pay off loan early?
How much does your credit score increase after paying off a car?
Should I pay off my car loan early?
You might consider putting extra cash, for example from a tax refund or work bonus, toward paying down your car loan. Whatever your reason may be, ask yourself whether the extra money you put toward paying off your car loan early could provide a more significant financial benefit elsewhere. Here are some pros and cons to consider.
Does paying off a car loan early affect your credit score?
That’s because open accounts showing a good record of on-time payments have a powerful effect on your score. Closing an account also may reduce your credit mix and average age of accounts. Here’s what to know about how paying off a car loan early may affect your credit score.
Should I pay off my car loan?
Before completely paying off your car loan, review your options to see which one makes the most sense for your financial situation, like: Pay off the full amount. In order to pay off the entire remaining balance, it may require a few hundred or thousands of dollars to be paid at once, depending on how much is left on your car loan balance.
Should you pay off a loan early?
Repaying a loan early usually means you won’t pay any more interest, but there could be an early prepayment fee. The cost of those fees may be more than the interest you’ll pay over the rest of the loan. If that’s the case, it makes more sense to keep making your regular monthly payments instead of paying the loan off early.