Is Paying Off My Car Loan Early a Good Idea?

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Updated on Sunday, February 14, 2021

The average new-car loan term is 70 months with nearly 20% of buyers choosing terms longer than 72 months, according to Experian. A long-term auto loan sounds tempting — it makes the car you want seem affordable thanks to a relatively low monthly payment. But you’ll most likely pay more in interest in the long run. Paying off that car loan early could save you money, but there are some potential disadvantages, too. Here’s whether you should pay off your car loan early and how to do it.

Advantages of paying off a car loan early

The biggest potential benefit is saving money. Here’s an example using one of our auto loan calculators:

A $30,000 six-year loan at a 7% APR costs $6,826 in interest. By paying an extra $90 toward the principal each month, you’ll trim a year off your loan and cut interest charges by $1,270. If you have an extra $210 a month, you’ll save $2,366. Notice the key phrase “toward the principal” — you want any extra cash to go toward the amount you borrowed, not interest and fees. You might have to give explicit instructions to your lender when you’re ready to pay off your car loan faster.

Other benefits

Simplify bill paying. When paying off a car loan early, you’ll wind up with one less bill to pay.

Stress less about negative equity. If you owe more on your car than it’s worth, what’s known as being upside down or underwater on your loan, paying extra to the principal means you could get rightside up quickly. Even if you don’t have negative equity, paying off the loan sooner means you’ll likely never have to worry about it.

Sell or trade a car easily. Rather than have to pay off a lender first, you could sign over the title whenever you want.

Disadvantages of paying off a car loan early

It could hurt your credit if you pay off a loan early. Your credit score is partially calculated based on payment history and the mix of loan types. Paying off a loan early means you’re missing the opportunity to have more completed payments on your credit history. If you only have one car loan — or few installment loans in general — polishing it off deletes a loan type from your credit profile.

Other downsides

Diminished cash reserves. Whether you’re planning on paying off your car loan quickly in a lump sum or over time by making payments to the principal, you won’t have that cash on hand any more.

Possible prepayment penalties. Most lenders do not have prepayment penalties on their auto loans, but it’s good to check just in case.

When paying off a car loan early makes sense

You should consider paying off your car loan early if you:

  • Have no other debt besides your mortgage, and you want to be rid of monthly car payments so you can free up money for other things.
  • Have a lump sum available or enough leeway in your monthly budget that you could pay off your loan without sacrificing your emergency fund or other important financial goals.
  • Want your monthly expenses to be lower by a certain point; for example, before you expand your family or by retirement age.
  • Need to improve your debt-to-income (DTI) ratio; for example, if you are planning to apply for a mortgage.
  • Need motivation to take charge of your money and start reaching toward other financial goals.

When paying off a car loan early does not make sense

Consider sticking to your original payment plan if you:

  • Have insufficient backup cash for emergencies. It’s always a good idea to have a rainy day stash. Here’s how much to save in your emergency fund. You don’t want to pay off your car loan, only to need a higher-interest personal loan because you’re short on cash and your car broke down.
  • Pay higher interest rates elsewhere. Other forms of debt such as credit cards and personal loans may have higher interest rates than your auto loan. It could be smart to pay off the loan with the highest APR first and then work those savings to pay off the next-highest APR loan.
  • Can invest the cash for a higher return. If your retirement, stock or other account has a higher earning rate than what you’re paying in auto loan interest, it may pay off to put any extra cash toward your investments.
  • Want to build your credit. Making car payments can help your credit report in two ways. It could add a longer history of on-time payments, and improve your credit mix.
  • Have a relatively short car loan. If you signed up for a three-year payment plan when you purchased your car, you may be perfectly happy paying it off as planned. You’re already minimizing your total interest expense, and you may be able to drive your car for years after you’ve forgotten what car payments are like.
  • Have prepayment penalties. These are rare for auto loans, as we mentioned, but if the penalty is higher than what you’d save in interest, it doesn’t make sense to pay off the loan early.

More ways to replace your car loan

Paying off your car loan early isn’t the only way to save on interest expense. If you have a high-interest car loan, instead of paying off your loan, consider one of these options:

Refinance your car. This can be especially helpful if you have improved your credit since you purchased your car, and you now qualify for better rates, or if interest rates in general have gone down. Here’s how to refinance a car loan.

Draw on a low-interest line of credit. If you have a personal or home equity line of credit (HELOC) that has a lower interest rate than your car loan, you could use funds from that to pay off your auto loan. Be aware, however, that you can generally no longer deduct interest from a HELOC on your tax return, unless you use the proceeds to buy, build or substantially improve your home.

Borrow from a relative or friend. If you’re paying 6% interest, say, on your auto loan, and your mom gets less than 1% on her savings account, perhaps you can work out a deal. You could borrow from her and pay her a better rate of return than what she is getting at the bank. You should only borrow from relatives and friends if you have a solid relationship, and if you would not be endangering their financial well-being if you should lose your job or something else goes wrong. Be sure to put any financial agreements in writing.

Trade your car in for a cheaper one. This could be helpful especially if you have positive equity in your car that can act like a down payment. For example, imagine your car is worth $24,000 but you only owe $20,000. You trade it in for a car that costs $13,000. The positive equity of your trade-in acts as a $4,000 down payment. So your new car loan is for $9,000, less than half of your former auto loan amount.

FAQs about paying off a car loan early

Yes — if it makes sense for your particular situation. There are benefits like potentially reducing the amount of interest you pay over the life of your loan. But it may not be worth it if you have to stretch your budget to uncomfortable limits.

If and when you’re ready to pay off your car loan, make arrangements with your lender to apply any extra payments toward the principal (more on this in a minute). If you’re ready to pay it off in one lump sum, ask your lender for what’s known as the payoff amount.

Once the lender receives your final payment, you should receive your title, or what’s known as a release of lien, by mail. Exact arrangements may depend on rules in your state — you could check with your lender or your state’s department of motor vehicles.

Not automatically. You will probably need to call your lender and ask it to apply extra payments to the principal. Otherwise, it may apply any additional payments toward interest or fees.