How to Know if You Should I Pay Off My Car Loan Early?

by | Jan 7, 2020

Living with debt takes a toll on one’s mind. For many, the road to debt-free living is a long and winding one with no end in sight. Fortunately, virtually all loan types can be repaid early—including your car loan. 

As a rule, paying off loans ahead of their amortization is always a good idea. Most car loans, whether purchased used or new, amortize between 5 and 6 years from the time the loan is taken out. However, paying them off ahead of time can save you a bundle on interest payments and can sometimes even result in tax advantages.

If you’re wondering if you should pay off your car loan early, we’ve got you covered. Below, we discuss the reasons for and against prematurely repaying your car loan, and explain how you can pay off your can faster than you might think.

 

Why You Should Pay It Off

Listed below are a few of the main reasons why you should consider paying off your car loan before its natural amortization. 

Save On Interest

Nobody likes having to pay interest on their loans. As long as you’re making interest payments, you’re bleeding cash. Therefore, getting rid of your interest payments should be a top concern if you want to save money and start building wealth. 

You can think of interest payments as the cost of borrowing the money for the car. In most cases, repaying the principal early will allow you to forego the interest payments you otherwise would have made. 

As an example, let’s consider an $18,000 car loan with zero money down at a 3.99% interest rate over a 60-month term. The total interest paid over the lifetime of the loan is $1,885—essentially, you’re paying a nearly two-thousand-dollar premium just to access the capital required to purchase the car. 

Now, if you were to ramp up your monthly payments by $75, you would pay off your car loan a year early (48 months). Consequently, you would pay only $1,504 in interest, which would save you $381 compared to a regular 60-month term. 

Save On Insurance

If you repay your car loan before its amortization, you may be able to renegotiate the terms of your car insurance policy successfully. Usually, insurance companies require vehicle owners to purchase full car insurance coverage if they acquired the vehicle through financing. If your car is fully paid off, then you can opt for partial-coverage car insurance. 

Removing collision coverage from your car insurance policy comes with its share of risks. However, if you feel like you’re overpaying for the coverage, you can opt to remove it from your policy once your car loan is repaid. Opting for no collision coverage can save you hundreds of dollars annually on insurance.

To take your savings a step further, you can also remove comprehensive car insurance coverage from your policy. Although you will forego reimbursement in the case of physical damages to your vehicle, slashing this coverage type can save you a lot of money every month in insurance payments. 

Improve Your Credit Score

Paying off your car loan ahead of time will do wonders for your personal credit score. The next time you apply for a loan or mortgage, your improved credit score will bolster your chances of getting approved by the lender. Even making an extra payment here and there can go a long way toward boosting your credit score and unlocking lower interest rates on future loans.

Redirect Money to Other Debt

Once your car loan is repaid, you will have extra money at the end of the month to dedicate to other expenses or debts. Freeing up additional money is a major confidence boost that can be put to good use. For instance, an extra $200 to spend on credit card debt or student loan repayments can accelerate your path to financial freedom. 

Why You Shouldn’t Pay It Off

There are a few reasons why you might want to consider holding off on repaying your car loan early. We’ve listed them below.

Prepayment Fees and Penalties

Before making your first extra car payment, read the fine print of your car loan agreement. If the terms mention prepayment penalties, then you may be better off repaying your loan over its regular timeline. Often, prepayment fees are included in car loan contracts so the lender can recoup any losses made by borrowers repaying early and skipping interest payments. 

In most cases, the financial benefits of missing a year’s worth of interest payments are offset by prepayment fees. However, to be on the safe side, it never hurts to do the math yourself to see whether your fees outweigh the cost savings of early repayment.

Your Credit Score May Worsen

Although it may sound like a paradox to some, repaying your car loan early may hurt your credit score. When you make steady, regular repayments over a long timespan, your credit score gradually improves. However, making early payments will shorten the timeline that you have to bolster your credit score, which might leave your score worse-off than it would be otherwise.

Lifestyle Changes

For some, dedicating additional funds to car loan repayments requires sacrifices to be made elsewhere in their budget. Consequently, the extra money required to repay a car loan early might result in undesirable lifestyle changes that might not be in the best interest of the borrower. Before making additional repayments, consider whether you can afford to so without your lifestyle or standard of living taking a hit. 

The Keys to Debt Repayment

There’s no magic bullet strategy to repaying your loans and achieving financial freedom. Whatever your strategy, it’s going to have to involve discipline, discretion, patience, and a ramped-up work ethic. 

Ultimately, a divide and conquer debt prioritization strategy is one that seems to work best for many individuals juggling multiple repayments. Under this arrangement, the borrower tackles high-interest debt first (such as credit card debt), and then gradually knocks off each debt stream one-by-one from highest to lowest interest.

There are three choices that borrowers must choose from when they’re ramping up their debt repayments. Borrowers can either reduce discretionary spending, earn more money, or shift spending from one expense (i.e., a $100 gym membership) to another (a $100 loan payment). 

To repay your debts faster—car loan or otherwise—you will ideally find a way to combine the three options above to silo more money toward your debts. Although it might seem like a pain, you will thank yourself later when you find out how much you saved on interest alone.

Charlie’s Verdict

If you’re wondering, “should I pay off my car early?” The answer is probably a resounding, “yes.” Unless your car loan comes with steep prepayment penalties, it’s always advised that you pay off your debt as early as possible. 

Alternatively, refinancing your car loan is another excellent way to save money on your car payments. How you decide to repay your car loan will ultimately hinge on the terms included in your car loan agreement. Specifically, that is whether your prepayment penalties exceed the accumulated savings of foregoing a year’s worth of interest payments. 

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