Pros and Cons of Paying Off a Car Loan Early

Pros and Cons of Paying Off a Car Loan Early

April 4, 2024

Car loans can be a big chunk of your monthly expenses. If you can pay off the loan early, you'll have more money left over each month and one less debt to worry about. But if you could use that money for something more important, it might not be the best idea to pay off your car loan early. 

So, when is it a good idea to pay off your car loan early? What are the pros and cons? 

Even though it seems like a good idea to lower your car debt quickly, you need to think about some key things before you do.


Pros of paying off a car loan early:


1. Save on the interest

Paying off your car loan early can help you save money on interest. The longer your loan lasts, the more interest you'll end up paying, especially if you have a high interest rate. So, if you can pay it off all at once, you'll likely save more.


2. Lower your debt-to-income ratio

Lowering the amount of money you owe compared to what you earn is a smart move. This is called your debt-to-income ratio. Usually, having a low ratio makes it easier to get approved for new loans or credit cards.

Paying off your car loan early can help shrink your debt-to-income ratio. This could make banks and other lenders see you as more reliable when you apply for new loans or credit cards.


3. You own the car

When you have a car loan, the lender actually owns the car and holds the title. But once you pay off the loan, the car becomes fully yours, and you get the title in your name. This means you own it outright. Plus, if you ever want to sell or trade-in your car, it's easier when you own it.


4. Avoid being upside-down on the car loan

Sometimes, people owe more on their car loan than what their car is actually worth. This is called being "upside-down" on your loan. If you have a long loan term and your car loses value over time, paying it off early can help you avoid this problem.

Being in an upside-down situation can be risky. If your car gets totaled in an accident, you'd still owe the lender the full value of the car plus the extra amount you owe. But if you pay off your car loan early, you can lower this risk.


Read: How to Get Rid of Negative Equity on Car Loan


5. Save more money for other expenses

If you pay off your car loan early, you might have extra money each month. This means you'll have more to spend on other bills or things you need. You could even save it for emergencies.


Cons of paying off your car loan early:


1. Prepayment penalty

Some lenders charge you a fee if you pay off your car loan before it's due. They usually make money from the interest you pay each month. Paying off your loan early means they won't get that interest, so they might charge you a penalty instead.

Check your car loan agreement to see if there's a penalty for paying early. If there's a penalty, you'll need to decide if it's worth it. You'll have to see if the penalty is less than what you'd save on interest by paying early.


2. Lowers your credit score

Paying off your car loan early might make your credit score go down a little because it takes away one of your credit accounts. But this drop should only last for a short time if everything else on your credit report is good.

If you're trying to improve your credit, it's better to keep making monthly payments on your car loan. Paying on time every month helps your credit score more than paying off the loan all at once or paying it off faster.


Read: How to Improve Your Credit Score


3. Might strain your finances

Paying off your car loan early could be tough on your finances. If you owe a lot and don't have much money saved, it might not be a good idea. It's better to focus on building up your emergency savings or paying off other debts first.


4. Better to pay off other high-interest debts

Before you rush to pay off your car loan early, think about where your money could be more helpful. If you have debts with higher interest rates like credit cards, personal loans, or student loans, it might be better to use your extra money to pay them off first.

While it might seem like a smart move to pay off your car loan early, it's important to think it through. It's only a good choice if it won't hurt your finances or if you don't have better ways to use your money. Before you decide, think about the advantages and disadvantages, look at your other debts, and figure out what's best for you.

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