Prior to deciding, weigh the advantages and disadvantages of paying off your auto loan early.
If you happen to have extra money, you might be wondering if it would be wise to pay off your auto loan early. Debt can be stressful, and for most people, auto loans are likely the second-largest debt they have.
Why Paying Off Your Car Impacts Your Credit Score
Many people finance new cars with auto loans, which means they pay interest on both the loan balance and the car’s purchase price. Longer car loan terms have been available recently in order to help borrowers better afford the monthly payments. Although the average repayment period for auto loans is 69 months, they can have terms as long as 96 months.
There are instances when borrowers are able to pay off their auto loan early. Early car loan repayment can reduce your costs and have an effect on your credit score. Depending on the terms of your loan and your unique financial circumstances, you should determine whether it makes sense to pay off your auto loan early.
Your payment history, credit history length, amount owed, credit mix, and whether you’ve applied for new credit are all taken into account when calculating your credit score. Let’s examine how repaying a car loan will impact each element of your credit score in more detail.
- Payment history: Early car loan closure won’t probably have a significant effect on your credit history if you have made all of your payments on schedule. It can guarantee that you won’t run the risk of paying bills late in the future. In fact, your credit report may show your positive payment history for up to ten years if you have no late payments. Approximately 33.5 percent of your FICO credit score is determined by your payment history.
- Credit history length: If your auto loan was one of your first loans, paying it off could have a negative impact on your credit score. However, the effect will likely be minimal. The duration of your credit history accounts for approximately 2015% of your FICO credit score.
- Amounts owed: By lowering your overall debt load, paying off your auto loan early can significantly improve your credit score. The amount owed represents approximately 20-30% of your FICO credit score.
- Credit mix: Should you decide to close your car loan, which is the only fixed-rate installment loan you have, it might have a little detrimental effect on your credit score. Your FICO credit score is based on approximately 2010% of your credit mix.
- New credit: Whether or not you’ve applied for new credit won’t be impacted by early car loan closure. New credit accounts for 10% of your FICO credit score.
Any drop in credit that occurs from paying off debt is usually only temporary. But in a few months, your credit score ought to rise if you pay off all of your other debts and maintain modest credit card balances.
What to Consider Before Paying Off Your Car Loan Early
Consider the benefits of saving money against possible drawbacks, such as having to pay a prepayment penalty or having less money for other objectives, before paying off your car loan early. Here are some questions to consider.
Does the Lender Charge Prepayment Penalties?
Some lenders charge prepayment penalties. Prepayment penalties may reduce your savings even though paying off a loan early usually results in financial savings. Prepayment penalties are typically assessed as a percentage of the loan balance; for example, 1% of the initial loan amount may be assessed if the loan is repaid ahead of schedule. As an illustration, suppose you had a $10,000 loan and your lender assessed a 1% prepayment penalty. In that case, you would have to pay $1000% of the prepayment penalty.
Prepayment penalties are often outweighed by the savings you would receive from paying off your loan early. Determine your situation’s possible interest savings and your prepayment costs.
Examine your loan agreement and Truth in Lending Disclosure form, or get in touch with your lender’s customer service department, if you’re unsure if your lender imposes a prepayment penalty.
Do You Have Other Debt with Higher Interest Rates?
While paying off debt is generally a good idea, there are situations when it might make more sense to focus on paying off other debt that has a higher interest rate before early car loan repayment. Generally speaking, auto loans have lower interest rates than personal loans or credit cards. Therefore, paying off those debts before a car loan could save you a lot more money.
Do You Have an Emergency Fund?
Prior to making additional debt payments, think about setting up an emergency fund. In order to help you avoid financial instability in the event of unforeseen expenses like medical bills, many financial experts advise having at least three months’ worth of necessary expenses saved.
Pros and Cons of Paying Off a Car Loan Early
- You could save money in interest.
- You would improve your debt-to-income (DTI) ratio.
- More money would be available for other objectives like saving or investing.
- You may face prepayment penalties.
- Your credit score may temporarily decrease.
- You may have less money for other goals like investing.
Examples of Paying Off a Car Loan Early
Here are a few situations where a borrower could pay off their auto loan early. These illustrations will help you weigh the benefits and drawbacks of repaying your auto loan early and determine if it’s the best course of action for you.
- You purchased a car from a buy-here, pay-here dealer. Compared to traditional lenders, buy-here, pay-here dealers charge significantly higher annual percentage rates (APRs). As per the Consumer Financial Protection Bureau (CFPB), the average buy-here, pay-here rates can range from 2015 to 2020. Paying off the loan as soon as possible can help you save a substantial amount of money because of the high interest rate.
- When you purchased the car, your credit was not so good. Generally speaking, borrowers with fair or bad credit have to pay significantly more than those with very good to excellent credit. If you had less-than-perfect credit when you purchased the car and have since raised it, you probably stand to gain financial savings by refinancing or paying off the loan sooner.
- You have a co-signer: If you obtained your vehicle loan with the assistance of a friend or relative, they will not be held accountable for the debt if you pay it off before the agreed-upon payback date.
If you can’t pay off your high-interest auto loan more quickly, you might want to think about refinancing. You might be eligible for a reduced rate that will enable you to pay off the loan faster and save a sizable sum of money.
How Long Does a Car Loan Stay on a Credit Report?
The closed account will stay on your credit report for ten years following the payment date if it is fully paid for and you have no past late payments. Your credit report will show any late payments you made before the balance was paid off for a period of seven years following the initial delinquency date.
How Long Does It Take for Your Credit Score to Go Up After Paying Off a Car?
Even though paying off a car loan may result in a temporary drop in your score, If there are no additional adverse factors influencing your credit score, you should see an improvement in it in a matter of one or two months.
How Much Do You Save on Interest When You Pay Off a Car Loan Early?
The amount of money you can save by paying off a car loan early is determined by the loan’s annual percentage rate (APR) and the remaining debt balance. Based on when you pay off your specific loan, you can use an auto loan calculator to determine how much interest you’ll pay overall.
Can Paying Off a Car Loan Early Have Other Cost Benefits?
Yes, potentially. You could reduce the insurance cost if the vehicle isn’t brand-new or isn’t worth a lot of money by increasing the deductible or removing the collision coverage completely. The lender requires full insurance coverage while there is a lien on the title; however, once your loan is paid off, that requirement is waived.
Does Refinancing a Car Hurt Your Credit?
There’s a chance that refinancing an auto loan will temporarily lower your credit score. Applying for a loan will result in a fresh credit inquiry, which may have an impact on your debt-to-income (DTI) ratio. Applications for new credit are seen by lenders as a risk. On the other hand, refinancing to a better rate can ultimately save you money if you make your payments on schedule.
The Bottom Line
Although paying off a car loan early can help you save money and reduce financial stress, it might not be the best course of action for you, depending on your circumstances. Sometimes it makes more sense to use your funds for other financial objectives, like paying off high-interest debt or setting up an emergency fund. Article Sources: Investopedia mandates that authors cite original sources to bolster their claims. These consist of government data, original reporting, white papers, and conversations with professionals in the field. When appropriate, we also cite original research from other respectable publishers. You can read more about the guidelines we adhere to when creating impartial, truthful content in our
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FAQ
Is it smart to pay off your car early?
It makes sense to pay off your car loan sooner if: You don’t have a lot of debt with high interest rates, like credit card debt. Lowering your debt-to-income (DTI) ratio is necessary before making a significant purchase, like a new home. Your auto loan interest rate is high.
What is the penalty for paying off a car loan early?
Some might charge you a prepayment penalty if you pay off your loan early or make additional payments. This is particularly prevalent with precomputed interest auto loans. The penalty is typically equal to two percent of the amount you still owe. Thus, you would have to pay $140 if you still had $7,000 left.
What happens if I pay an extra $100 a month on my car loan?
If you pay more, your car payment won’t decrease but the loan will be paid off sooner. Depending on how quickly you pay off the loan and how high your interest rate is, making additional payments may also help you save money on interest.
Read More :
https://www.investopedia.com/what-happens-early-loan-payoff-7505190
https://www.caranddriver.com/auto-loans/a43149185/paying-off-a-car-loan-early/