Why is it even a question? Of course, if anybody could pay off a loan early, they’d do it in a heartbeat. Who wants a loan hanging above them ominously? The same would go with car loans, but unfortunately, much like other types of loans issued by banks in America, paying off early can get you into a new bevy of problems. As if this wasn’t a favor to the banks. So, here’s the question that you can ask your advisor: can you pay off a car loan early?
Bear in mind that not all loans are issued equal. All come with different terms, different conditions but the most prevalent one is a prepayment penalty. As the name implies, you can be penalized for not following the term set by the bank for repayment of the loan. You give them money; they charge an interest. You do them a favor and give them the money early and they penalize you: God bless America! Car loans follow the same principle; repaying a car loan is actually a much better option than refinancing or other solutions, but if you have a loan with a prepayment penalty, you could end up paying more in penalties and fees than what you might’ve paid in interest payments.
So, here’s a comprehensive answer to the question: can you pay off a car loan early?
Why Should You Pay Off A Car Loan Early? (Pros)
There are plenty of pros towards paying off your car loan early if you can manage to do so. Most people actually can afford to pay off their loans early with a bit of financial planning, but most choose not to do so owing to their loan terms or due to their own financial infidelity. However, here are some of the reasons why you should pay off your car loan early.
Save on Interest Payments:
The foremost benefit of paying off your car loan early would be the enormous amount you could potentially save in interest repayments. Think about it. If your loan amounts to $20,000 spread out over 60 months at a 15 per cent interest rate, you could save up a good amount on interest if the term were to shorten down to, say, 50 or 45 months. Similarly, when you pay your monthly or biweekly premium/ instalment on the loan, you’re paying a certain amount of interest on top of the actual amount you borrowed. By paying off your car loan early, you can save up on the payments and ultimately save up on the interest payments that were eventually going to come out of your paychecks. For example, a $15,000 car loan at a 7 percent interest rate would cost you $2821 in interest over a five-year period. Add $50 a month to your payment and you would reduce your car loan by 10 months, and save $487 in interest. That’s smart financial advice.
Saving Up for a New Vehicle:
The money you save on interests and subsequent payments after paying off your car loan can be then diverted towards saving up for the down payment of a new vehicle. After all, a car is a depreciating asset; five years down the road, it won’t be worth what you paid for it. So, paying off a car loan early can also pave your way towards a new car.
Drive Down your Debt-to-Income Ratio:
A lower debt-to-income ratio means good for your financial health. It means that you earn way more than what your debt repayments take out from your check. A lower debt-to-income ratio can contribute heavily towards a good credit score and credit history, meaning more of your money is freed up for your personal use and less goes towards repayments.
Who doesn’t want to be in financial manna? Unfortunately, debt is a crippling thing and repayments can get the better of you and your finances. Paying off your car loan early can mean a greater period of financial freedom and stability and can be the difference towards you achieving financial fidelity.
Cons Of Paying Off A Car Loan Early
Yes, these cons do exist. You could get into even more payments, fines and fees should you choose to pay off your car loan early. Following are the examples of situations when paying a car loan off early can fire back.
As explained beforehand, prepayment penalties seem like a harmless option at first. But a year or so down the road, when you think you can pay off the remaining amount in a single lump-sum payment, you get hit with the clause you cared the least about. That’s the main problem with paying off your car loans early. If your loan contained such a clause, well, paying off early would do more damage than good to your credit score and your fiscal fidelity. The prepayment penalty and the associated fees could potentially run you more than the interest payments, getting you into a loss overall.
Hurts Credit Score:
Not directly, but paying off a car loan early and closing the associated account will count much towards translating into a lower credit score. Paying off the loan itself does little to bring your credit score down, but the associated closing of accounts and the processing of the bank leads to a condition called premature payment, wherein you are assessed as a credit risk, lowering your overall credit score. Therefore, do take the suggestion of paying off your car loan early with a grain of salt.
Can Disturb Your budgeting:
Trying to pay off a car loan early will involve you ballooning up the monthly payments, bumping up the rates or even making a big one-off payment every year or six months towards paying off the loan early. This can obviously take a toll on your financial health and can disturb your other priorities, long-term and short-term. Therefore, if you intend to pay off a car loan early, do iron out the details and plan accordingly so that the rest does not get disturbed.
Can Hurt Other Debt Repayments:
That’s just about car loans. Americans have loads of other debts; student loan debts, debit and credit card debt and so on. Focusing on one debt to repay it early can neglect the other payments; and if done without much care and consideration, can lead to falling behind on other loans, which will make the whole affair an exercise in futility. So, do consider other loans and their repayments before setting out on paying off your car loan early.
If the above-mentioned four issues don’t concern you and your car loan repayments, congratulations, you can pay off your car loans early and enjoy all the benefits it offers. As for how you can do it, here are six steps that can help towards paying off a car loan early.
How to Pay off a Car Loan Early?
Following are a few steps on how to pay off your car loan early,
- Pay half your monthly payment every two weeks.
- Round your payments up to the nearest $50.
- Make one large extra payment per annum.
- Make at least one large payment over the term of the entire duration of the loan.
- Never skip payments.
- Get your car loan refinanced.