Is It Better to Pay Off a Car Loan Early or Make Payments?

The decision of whether to pay off a car loan early or make payments is a personal one that depends on your financial situation and goals. There are both pros and cons to each approach, which we will explore in this article.

Pros of Paying Off a Car Loan Early:

• Save money on interest: This is the biggest advantage of paying off your car loan early. The longer your loan is open, the more interest you will pay. By paying off your loan early, you can save a significant amount of money on interest charges.
• Personal satisfaction of full ownership: When you are still making payments, your lender owns your vehicle. Once it is paid off, you will receive the title and the car will become your property.
• More wiggle room in your budget: The average car payment in America is $725 a month. From home improvements to saving for your kids’ future, freeing up an extra $725 a month opens a ton of possibilities.
• Improved debt-to-income ratio: Your debt-to-income ratio is a measure of the amount of money you bring in versus the total amount of your debt. By paying off your car loan in full, you will reduce your debt load and in turn, lower your debt-to-income (DTI) ratio.
• No more risk of an upside-down car loan: Over the last few years, used cars have sometimes cost more than new. However, the market is beginning to stabilize. In May 2023, The U.S. Bureau of Labor Statistics Consumer Price Index showed that prices for used cars and trucks fell by 4.2%.
• More freedom with insurance choices: When you are financing a car, you are typically required to carry full insurance coverage. Those who lease their cars are usually required to carry higher liability limits, too, as a stipulation of their contract.
• Streamlined process if you decide to sell or trade in your car: It can be a pain to sell a car when you still have a loan. Before you can transfer the title to the new owner, you need access to the title. In other words, you will need to pay off your vehicle first, either with the proceeds of the sale or by some other means. By owning your car free and clear, you will have the title in hand when you want to sell, making the entire process much simpler.

Cons of Paying Off a Car Loan Early:

• Prepayment penalties: Some lenders charge a fee for repaying your loan in full before the end of the term, especially those that issue auto loans for bad credit. This is called a prepayment penalty.
• Could see a temporary dip in your credit score: Your credit score is calculated using a number of factors, including your credit mix. Generally, borrowers who have multiple types of debt have a better credit mix than those with only one or two kinds of debt.
• May be more advantageous to pay off other debt: There is good debt and bad debt. Generally speaking, cars purchased with a large down payment and with a short-term car loan are considered to be good debt. That’s because large down payments usually mean lower interest rates. Further, a shorter loan term means you will pay less in interest over the life of the loan.
• Could cause financial strain: Depending on how much you owe and your current financial situation, paying off your car loan early might cause undue hardship. If paying off your car loan would deplete your savings, it is probably better to build your emergency fund or pay off debt instead.

Strategies for Paying Off a Car Loan Early:

• Make a lump sum payment: This is best for people who have received a windfall or just don’t like carrying debt.
• Pay more than the minimum payment each month: If you can’t pay off your car loan with a single lump sum, you can still save in interest over time by paying more than the minimum amount due each month. Create a budget to determine how much you can safely tack on to your monthly car payment without falling behind in other areas.
• Make a payment every two weeks: This is best for people who don’t mind the extra time it takes to make more than one monthly payment. You can save a chunk of change by paying on your car loan every two weeks, rather than monthly. With this strategy, you will end up making 13 payments a year rather than 12, speeding up your repayment and reducing the amount you pay in interest.

Whether to make payments or pay off a car loan early is a personal choice. Each strategy has advantages and disadvantages, so the best option for you will rely on your unique situation. Do your homework and carefully consider the benefits and drawbacks before paying off your auto loan early.

Additional Resources:

• NerdWallet: Should You Pay Off a Car Loan Early?
• LendingTree: Should I Pay Off My Car Loan Early?