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

Buying a new car is an exciting experience But that excitement can fade once the car payments start rolling in month after month. You may be wondering if it’s better to pay off your car loan early or continue making monthly payments There are pros and cons to both approaches. In this article, we’ll break down the key factors to consider when deciding whether to pay off your auto loan ahead of schedule.

Pros of Paying Off a Car Loan Early

Paying off your car loan early has some big advantages:

Save Money on Interest

This is the biggest motivator for paying off a car loan early. The longer you carry auto loan debt, the more interest you’ll pay to the lender. By paying off the loan faster, you reduce the total interest costs.

For example, if you have a $20,000 auto loan at 6% interest over 5 years, you’ll pay about $2,290 in interest charges. But if you pay it off in just 2 years, you’ll only pay around $960 in interest – saving over $1,300.

Own Your Car Outright

There’s nothing like the feeling of full ownership. When you’re still making payments, the bank technically owns your car. Once the loan is paid off, you’ll have the title and own your vehicle free and clear.

Improved Cash Flow

Car payments take a big chunk out of monthly budgets The average new car payment reached over $600 per month in 2021. That’s money you could use for other goals if you didn’t have a car payment

Build Credit History

Responsibly managing installment loans like auto loans helps build your credit profile. But once you’ve established a solid history, the benefits of keeping the loan solely for credit reasons drops. Paying it off early can free up credit for other needs.

Simplify Selling or Trading In

Selling or trading in a vehicle is easier when you hold the title instead of the bank. It removes steps from the process and gives you more flexibility.

Cons of Paying Off a Car Loan Early

However, there are some potential downsides to paying off your car loan ahead of schedule:

Prepayment Penalties

Before paying off your loan early, check the terms for prepayment penalties. Some lenders charge fees for early repayment. This could eat into the savings from paying it off faster.

Temporary Drop in Credit Score

When you close an installment loan, it can cause a short-term drop in your credit score. This is because it lowers your credit mix until you replace it with another loan. However, once your credit mix builds back up, your score will rebound.

Lost Chance to Invest Extra Cash

Money put toward paying off a low-interest car loan early could potentially earn higher returns if invested instead. Run the numbers to see if you’d come out ahead investing versus early loan payoff.

Financial Strain

Depending on your situation, putting large sums toward your auto loan could strain your budget or deplete savings you need for other goals or emergencies. Make sure early payoff aligns with your broader financial plan.

Strategies for Paying Off a Car Loan Early

If you decide paying off your car loan early makes sense, here are some tips for paying it down faster:

• Make extra principal payments. Paying extra each month is the easiest way to pay off your loan early. Even small amounts go a long way. Just be sure the extra payments go to reducing principal.

• Pay biweekly. Making half payments every two weeks, rather than one monthly payment, allows you to make the equivalent of one extra payment per year.

• Refinance for a lower rate. Refinancing could potentially lower your interest rate and monthly payments. This makes it easier to pay more toward principal each month and pay off the loan faster.

• Use windfalls. Tax refunds, work bonuses, inheritance money, or any other financial windfall can be put toward the principal on your car loan to slash the balance.

• Sell or trade in your car. You could pay off the loan immediately by selling your car or trading it in toward a less expensive vehicle.

Key Factors to Consider

There are a few key factors to weigh when deciding if you should pay off a car loan early:

• Your interest rate – higher rates make early payoff more advantageous.

• Your other debts and financial goals – be strategic about which debts to prioritize.

• Your budget and emergency savings – don’t overextend your finances.

• Prepayment penalties – check your loan terms first.

• How long you plan to keep the car – longer time horizons favor payoff.

The choice between making payments or early payoff comes down to aligning with your individual financial situation and goals. Run the numbers, understand the tradeoffs, and pick the approach that maximizes your money. With strategic planning, you can decide whether to pay off that car loan ASAP or not.

A $30,000 car loan for 60 months will result in a monthly payment between $500 and $700, depending on the interest rate. For example, at a 5.8% interest rate, the monthly payment would be around $520, according to Edmunds.

The 50/30/20 rule is a budgeting guideline that suggests allocating 50% of your after-tax income to needs, 30% to wants, and 20% to savings and debt repayment.

Making an extra $100 monthly payment on your car loan will reduce the total amount of interest you pay and shorten the loan term.