Should You Pay Off Your Car Loan Early?

Paying off your car loan early could be one way to help you free up more room in your budget if you want to reduce your monthly expenses. But before you pay off your car loan, it’s helpful to understand the costs and benefits to make the best decision for your situation.

Keep reading to learn what to consider before paying off your auto loan early, including how it may affect your credit score and different ways to pay off your loan.

Is paying off your car loan early a good idea?

Depending on your loan terms and your finances, paying off your loan early could have several benefits and drawbacks.

Pros

• You might save money on interest: The sooner you’re able to pay down your loan, the less you’ll likely spend on interest (the cost of borrowing).¹ The exact amount of interest you save in the long run depends on your remaining loan balance, your interest rate and how much time is left on the loan.
• You could lower your debt-to-income (DTI) ratio: Your DTI ratio compares your monthly debt payments to your gross monthly income.² Lenders use DTI to assess whether you have room in your budget for another loan. Paying off your loan reduces your monthly debt amount, which in turn lowers your DTI. A lower DTI may help you qualify for favorable terms on future loans.
• You could own your vehicle sooner: Paying off your car loan early means you'll own your vehicle outright sooner and no longer have to make monthly loan payments. Since auto loans are typically secured by the vehicle, your lender may repossess your car if you fail to make payments. Paying off your loan eliminates that risk.³
• You could avoid owing more money than your car is worth: Being upside-down on your car loan means you owe more money than the vehicle is worth.⁴ Cars depreciate in value over time, so the faster you pay down your balance, the less risk you have of being in this situation.

Cons

• You may pay a prepayment penalty: Many lenders allow borrowers to pay off a car loan early, but some loan agreements include a prepayment penalty, which is a fee charged if you pay off your loan before the end of your repayment term. You’ll want to review your loan agreement and contact your lender to find out whether a prepayment penalty applies to you.
• You may reduce your savings: Making a large payment toward your loan may be a big step forward, but you’ll want to make sure you feel comfortable reducing the cash you have saved up. Think about how you’ll afford an emergency if you need to take time to rebuild your savings.
• You may not be able to pay off other debts: Paying off your loan all at once may limit how much extra money you can put toward paying off other debts, especially ones with larger balances or higher interest rates.
• You may need to reduce your spending: If paying off your auto loan early stretches your budget, you may need to cut back on discretionary spending like dining out, your annual vacation or subscriptions. Remember, paying off a loan is just one piece of your financial picture.

Does paying off your car loan early affect your credit score?

Paying off your car loan early may cause a temporary drop in your credit score, but the impact can vary depending on your credit history.⁵

Paying off your loan may affect your credit mix, which consists of the different types of credit accounts you have, such as credit cards and installment loans. Your credit mix is one of several factors that affect your credit score, along with your payment history, amounts owed, length of credit history and newly opened accounts.

However, paying off any loan early doesn't erase your payment history. Whether a loan is in good standing and is paid off early or on time, the loan history will likely stay on your credit report for up to 10 years.⁶ This means the history of on-time payments could help your credit score even after the loan has been paid off.

What should you consider before paying off a car loan early?

Once you have a better understanding of the potential benefits and drawbacks of paying off your auto loan early, consider your individual financial situation.

• The funds you have on hand: First off, consider whether you have enough money in the bank. Even if you do, will you have any funds left over for other financial priorities? Maintaining financial flexibility could give you peace of mind.
• Your budget: If eliminating a monthly payment will help free up more room in your budget and give you more financial freedom, paying off your car loan sooner may be the right choice for you.
• How much you might save on interest: The amount you’ll save in interest may vary based on the loan terms, the remaining balance and whether you must pay a prepayment penalty, which would reduce the amount of your savings, if any.
• Your credit history: Taking out a loan and making payments on time helps build your credit history. If you pay off your car loan early, you may see a temporary dip in your credit score, whereas continuing to make on-time payments each month could help you build credit.
• Your interest rate: If having a new personal loan with a lower interest rate could help your cash flow or budget, you could look into refinancing. When you refinance, the new loan pays off the current high-interest car loan early. Then you’d start making payments on the new loan with a lower interest rate.

Ways to pay off your car loan early

You can pay down your auto loan early in a few different ways. Think about which payoff strategy makes the most sense for you.

• Pay more than the minimum monthly payment: If you can afford it, think about paying more than the minimum amount due on your loan each month, which may reduce its balance and save you interest over the loan term.
• Make more than one payment each month: Consider making additional monthly payments toward reducing your balance.
• Pay off the remaining balance with a lump-sum payment: If you decide you want to pay off the remaining balance all at once, you’ll submit a lump-sum payment to your lender. But before you send a payment, contact the lender and get an official payoff letter, which will include the exact amount you need to send and when the lender needs to receive it.

Before you make any extra or larger payments, you’ll want to make sure the additional money goes toward the loan principal. Check your lender’s policies and your loan terms to confirm how that money will be applied to your balance.

---

---

Make the right decision for you

Whether it makes sense to pay off a car loan early depends on a variety of factors, including the terms of the loan, your budget and your other financial circumstances. Take the time to review your loan agreement, request a payoff letter from your lender and consider how paying off your loan early may affect your financial goals now and in the future.

By weighing the pros and cons, you’ll be able to make the right decision for your situation.

Sources

1. https://www.consumerfinance.gov/ask-cfpb/is-it-better-to-pay-off-the-interest-or-principal-on-my-auto-loan-en-845/
   
2. https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-en-1791/
   
3. https://consumer.ftc.gov/articles/vehicle-repossession
   
4. https://www.experian.com/blogs/ask-experian/how-to-get-out-of-an-upside-down-car-loan/
   
5. https://www.experian.com/blogs/ask-experian/does-paying-off-a-car-loan-early-hurt-your-credit/
   
6. https://www.experian.com/blogs/ask-experian/paid-auto-loan-remains-on-credit-report/