does it make sense to pay off car loan early

Does It Make Sense to Pay Off Your Car Loan Early?

Paying off a car loan ahead of schedule can save you money on interest and get you out of debt faster. But is it the right move for you? Here’s what to consider when deciding if you should pay off your auto loan early.

The Benefits of Paying Off a Car Loan Early

Paying extra on your car loan principal can have several advantages

• Save money on interest. When you take out a car loan most of your early payments go toward interest. By making extra principal payments you reduce the amount of interest you pay over the life of the loan.

• Pay off your loan faster. Putting extra money toward your principal will help you pay off your car sooner. Instead of having a payment for 5-6 years, you may be able to pay it off in 2-3 years.

• Build equity faster. Car loans can put you in an upside-down position where you owe more than the car is worth. Paying down principal faster helps you build equity in the vehicle sooner.

• Free up monthly cash flow. When your car is paid off, you can take the money you were putting toward your car payment and use it to build savings, pay off other debts, or work toward other goals.

• Avoid repossession. If you don’t make your payments on time, the lender can take your car back. Paying it off eliminates this risk.

• Improve credit utilization. Paying off installment loans like car loans can improve this key factor in your credit scores.

Potential Downsides of Early Payoff

There are many good things about paying off your car loan early, but there are also some bad things that could happen:

• Prepayment penalties. Review your loan agreement to see if you’ll be charged a penalty for paying off the loan early. Calculate if the penalty outweighs interest savings.

• Temporary credit score drop. When you close an installment loan, your credit score may dip because your overall credit mix changed. But it will recover quickly as other positive factors compensate.

• Opportunity cost. Using your extra funds to pay off debt early means you can’t use that money for other goals like building an emergency fund or investing for retirement.

Tips for Paying Off Your Auto Loan Faster

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

• Make biweekly half-payments instead of monthly payments to fit in an extra payment per year.

• Add any windfalls like tax refunds, bonuses, or gift money toward the principal.

• Increase your monthly payment, even if it’s only by $20 or $50.

• Round up each payment to the nearest $50 or $100.

• Apply any savings from refinancing or lowering your auto insurance premiums to the principal.

• Pick up a side gig and use that income to supplement your payments.

• Review expenses and look for areas to cut back so you can redirect that money toward extra principal payments.

Should You Pay Off Your Auto Loan Early?

Here are some signs it may make sense to pay off your car loan ahead of schedule:

• You have a solid emergency fund of 3-6 months’ expenses.

• You’re currently paying PMI on a mortgage; paying off your car loan could help you reach 20% home equity faster.

• Your interest rate is high, over 6-8%. The savings will be greater.

• You can pay it off within 1-3 years. It’s not worth it if it will take 5+ years.

• You plan to pay off other debts with medium or high interest rates quickly. Getting your car fixed first gives you more money to spend on the others.

The bottom line is paying off your car loan early can be a smart money move in many situations. But make sure you’ve got your other financial bases covered first before putting extra money toward your auto loan.