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.
Advantages of paying off your car loan early
With an auto loan, the interest is paid over the course of the loan. A portion of your monthly car payment is used to cover the interest on the loan as well as the principle and lump sum you borrowed.
Since most auto loans have simple interest, the monthly interest you pay is determined by the remaining principal amount you owe. As a result, you should make sure that any additional money you pay each month toward the principal of your auto loan when you do so. By doing this, you shorten the loan term and pay less interest.
Suppose, for instance, that you took out a $30,000 auto loan with a 6% interest rate and a 60-month term, your monthly payment would be $579. 98, and you would have to pay almost $4,800 in interest overall. But if you added $100 to your monthly payment for the duration of the loan, you could pay it off in 50 months and avoid paying about $800 in interest.
Even though it’s unlikely that most borrowers will make extra payments each month for the duration of the loan, you can still save money by occasionally making larger principal payments. To find out how making additional payments could lower your auto loan interest and term, use NerdWallet’s extra payments calculator.
Make sure your auto loan uses simple interest before assuming paying it off early will save you money on interest. Precomputed interest is a technique used by a few lenders where interest is calculated up front and the monthly amount stays constant. Even if you pay off your car loan early with precomputed interest, you might still be responsible for the entire amount owed. This could imply that you won’t ultimately save money by paying off the loan early.
Lower your debt-to-income ratio
The total of your monthly debt payments divided by your gross monthly income is your debt-to-income ratio, or DTI. This ratio is used by lenders to assess whether your income now will cover living expenses and debt payments.
When approving loans and calculating how much you qualify to borrow, lenders take your DTI into account. Removing your auto payment from the DTI calculation may enable you to get future loans at a reduced interest rate.
Avoid owing more than your car is worth
Being upside down on a car loan is less likely if you pay off your loan early. You might end up owing more than the car is worth if your loan term is lengthy and your car loses value during that time. If you sell your car or total it in an accident, you may be responsible for the difference between the loan balance and the car’s market value.
Being upside down in the near future is unlikely in the market of expensive used cars and dealer markups that exists today. However, even if you took out a long-term loan and paid a lot more than the car’s sticker price, you could still lose everything if car prices start to decline.
Own your car sooner
The car loan lender technically owns the vehicle and retains the title until the loan is paid off. As a result, you will gain complete ownership and have the title in your name sooner if you pay off your auto loan as soon as possible. Additionally, if you own your car, it may be simpler to sell or trade it in.
Disadvantages of paying off your car loan early
Although they are less frequent than they once were, some lenders still impose fees on early car loan repayments. Check your loan agreement to see if there are any penalties for early repayment. If so, calculate whether the interest you will save outweighs the cost of early repayment of the car loan.
Preventing better use of your money
Prior to making an early auto loan payment, think about how it will fit into your overall financial plan.
Will contributing more funds to your auto loan keep you from paying off more expensive debt first? Credit cards typically have interest rates that are higher than those on auto loans, and their rates are adjustable and subject to increase. Since the majority of auto loans have fixed interest rates, you might be better off paying off credit card debt or other high-interest debt first.
Should you prioritize paying off your auto loan in order to avoid cash-flow issues later on, such as not being able to afford unanticipated home repairs, it’s a good idea to put any extra money you have set aside for unforeseen expenses into an emergency fund.
Additionally, take into account long-term savings like retirement funds when talking about savings. Assume, for instance, that your auto loan has an extremely low interest rate (e g. , less than 6%). If so, allocating any additional funds to retirement savings with a higher interest rate and tax benefits might be more advantageous.
Lowering your credit score
Although it’s not always the case, some borrowers think that paying off their auto loan will improve their credit score. Your credit score is influenced by a variety of factors, such as your payment history and the types of credit you have, such as loans and credit lines.
Early repayment of your auto loan removes it from your mix of credit accounts, which may result in a minor drop in your credit score. However, if there aren’t any other adverse factors influencing it, any decline in your credit score ought to be transient.
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How to pay off a car loan early
If you determine that it would be beneficial for you to pay off your auto loan more quickly, there are a few different strategies you can use.
Make a lump sum payment
You could settle your auto loan in full if you wind up with a sizable sum of money. The balance displayed on a statement or online account should not be trusted. Rather, request the loan payoff amount from your lender for the date you intend to make the payment. This amount will include your remaining balance, interest, and any other outstanding fees.
Alternatively, you could pay a portion of your balance in full. Speak with your lender to make sure all of the money is applied to the principle so you can benefit from paying off your loan more quickly.
Make biweekly payments
Some lenders allow you to make biweekly auto loan payments. You would pay half of your auto loan payment every two weeks in order to accomplish this. As a result, 13 payments rather than 12 are made in a year, which speeds up your payback schedule and lowers the amount of interest you pay.
Since not all lenders accept biweekly payments, first check with your lender. Furthermore, a lot of them are unable to accept biweekly payments via autopay.
Pay extra on your monthly car payment
If you are unable to pay more each month, make a larger-than-minimum payment when you are able to. For instance, if your required minimum car payment is $634, you can round up to $700 or add $50 to make $684. Make sure that any additional money you pay toward the principal of your loan is applied to it.
Once more, confirm that your lender takes larger-than-minimum payments by contacting them. Ask how the additional funds are applied to your loan as well. Some lenders apply the excess to the principal automatically. Others demand that you specify that any excess payment be made to the principal, for instance, by attaching a note to your payment.
Another way to save on interest without paying off your car loan
If all you want to do is lower the interest rate on your auto loan without paying it off early, you can also refinance your vehicle. If your credit has improved or the interest rate on your car loan has decreased since you took out the initial loan, you might be eligible to refinance to a lower rate. However, be advised that refinancing to a longer term may result in a higher final interest payment amount.
FAQ
Is it smart to pay off your car loan early?
In summary, you can save money by paying off your car loan early, provided that there isn’t a significant prepayment penalty assessed by the lender and you don’t have any other high-interest debt. Making a few extra payments can significantly lower your expenses.
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.
Will my credit go down if I pay off my car early?
A lot of customers believe that paying one less monthly bill will improve their credit score, whether it’s to save money or simply to feel better about themselves. Remarkably, the reverse can also happen: your credit score may decline if you pay off a car loan early.
Is it better to pay off car loan or down payment?
You can get a shorter loan term with a larger down payment, which will shorten the time you have to pay back the loan. Yes, this entails paying more money up front in order to save money later. Since cars lose value the moment you start driving them, a short loan term is very beneficial.
Read More :
https://www.nerdwallet.com/article/loans/auto-loans/pay-off-car-loan-early
https://www.lendingtree.com/auto/refinance/pay-off-car-loan-early/