Paying Off Your Car Loan Early: Pros and Cons

There’s no one-size-fits-all answer to whether it’s better to pay off a car loan early. It depends on how much you owe, how much you can afford, and your reasons for wanting to eliminate the debt.

In general, paying off a car loan ahead of schedule could be a helpful option if you:

• Have a high interest rate on the loan.
• Are “upside down” on the vehicle, meaning you owe more than what it’s worth. (This is also called negative equity.)
• Don’t have a lot of other high-interest debt, like credit cards, and want to streamline your budget.
• Are focused on reducing debt.
• Already have a solid emergency fund in case unexpected expenses arise.
• Need to lower your debt-to-income ratio (DTI) to qualify for another loan, such as a mortgage.

Analyzing your financial situation, including how much cash you have available to pay off your car loan, can help you decide if it’s doable and something you should consider.

Paying off a car loan early can yield some financial advantages that might make it tempting to pull the trigger. Here are some of the best reasons for getting rid of a car loan sooner rather than later:

• Unless you’re at the end of the loan term, you’ll save money on interest.
• Paying off a car loan early can reduce the risk of becoming “upside down.”
• The sooner you pay off your car loan, the sooner you’ll own it.
• Owning your car outright could lower your premiums if a lender does not obligate you to maintain a certain amount of coverage. (The lender usually requires full coverage until it’s paid off.)
• Paying off a car loan (or other debt) early can improve your debt-to-income ratio.
• You can get closer to debt freedom if you have one less monthly payment.
• There’s a psychological benefit since you have less debt to worry about.

Paying off a car loan early can also make saving easier since you no longer have to earmark several hundred dollars in your monthly budget for debt payments. You might use the money that you were spending to your car loan to save for new furniture, a vacation, or even a down payment on a home instead.

Paying a car loan off early isn’t always ideal, and it may not work for everyone. Here are a few downsides to consider if you’re leaning toward early repayment:

• Your lender may charge a prepayment penalty to recoup some of the lost interest charges, which can add to your total payoff amount. Check your loan terms and conditions.
• Paying off a car loan early could put pressure on your budget if you’re draining your savings.
• You might benefit more from using the money to fund another financial goal, like knocking out high-interest credit card debt or investing.
• If the interest rate on the loan is low, you might not save a lot of money on interest charges with an early payoff.
• You may get caught in a cash crunch if an emergency happens but you’ve used most of your savings to pay off your car loan.
• An early payoff might affect your credit score since you’ll no longer benefit from having on-time payments reported to the credit bureaus.

Eliminating your car loan could also lead to lifestyle inflation if you have extra money in your budget to work with each month. If you don’t have a specific goal, like saving or repaying other debts, that could make it easier to make unnecessary purchases. You should consider whether you’re getting ahead financially if your spending isn’t benefiting you somehow.

If you’ve weighed the advantages and disadvantages of paying off a car loan early and decided it’s right for you, the next step is figuring out how to do it. There are a few options for paying off a car loan early, and your lender might have specific instructions for what you’ll need to do to fulfill the loan.

• Review the pros and cons. Really weigh the pros and cons of an early car loan payoff to ensure it’s the right move for you. That includes going over your budget and savings to see how much cash you can afford to part with.
• Choose a payoff method. If you’d like to pay off a car loan early, you could send a lump payment to your lender for the remaining amount. The other option is to increase your monthly payments. Which one you choose ultimately depends on whether you’re comfortable parting with a large amount of cash all at once or spacing your payoff out over a series of larger payments.
• Determine the payoff balance. If you plan to make a lump sum payment, you’ll need to know the exact amount to pay. Your most recent statement should include the payoff amount, the principal balance and interest, and any prepayment penalties or other fees you might be responsible for.
• Contact the lender for repayment instructions. Now that you know how much you need to pay, you can reach out to your lender to find out how to make the payment. You might be able to schedule your car loan payoff online using an electronic payment from your bank account. If you have to pay in person at the bank that holds your loan or mail a check, ask for a written receipt or confirmation of payment.

Should you decide to go the extra payments route instead of a lump sum, ensure any extra amount you pay goes to the principal, not the interest. Otherwise, you could be speeding up the payoff of the interest only.

Is it bad for your credit score to pay off a car loan early?

Paying off a car loan early could hurt your score if it affects your credit utilization or your credit age. Both of those are key factors used in the FICO® credit scoring model.† However, any hit you experience might be small, and your score might rebound fairly quickly if you’re making on-time payments to other debts.¹

Is it better to pay off a credit card or car loan first?

Whether it’s better to pay off a credit card or car loan first depends on how much you owe and your interest rates. For example, if you owe $10,000 on a credit card with a 19.99% APR and the same amount on a car loan at 4.99%, the credit card costs you more interest each month. You’ll save more on interest by paying the credit card off first.

Can you refinance a car loan?

Yes, you can refinance an auto loan. Refinancing a car loan means taking out a new loan to pay off the old one. It might make sense to refinance your car loan if you’re trying to get better terms, like a lower interest rate or monthly payment. You might also choose to refinance an auto loan if you want to move to a different lender.

Can you pay off a car lease early?

Leasing a car versus buying one might appeal to people who don’t want to be locked into a loan for the long term. Your lease might include a clause that allows you to pay it off early and return the vehicle. However, the leasing company might charge a sizable cancellation fee.