At a Glance

This is more a question of “should” than “can.” The option to pay off a car loan early is always available. It’s not always advisable. There are circumstances that favor just making your monthly payments on time. Other scenarios make an early payoff a more prudent option. In this article, we’ll go over each of these situations and whether they’re a good idea for you.

A car loan is a secured loan. The vehicle itself is the security that guarantees you’ll pay the loan. When the last payment is made, the borrower owns the vehicle outright. That’s all the incentive some people need to pay a car loan off early. Unfortunately, this can sometimes lead to financial unmanageability in other areas. The payoff needs to be carefully budgeted.

Prioritizing Debts Before Paying Off Your Car Loan

Let’s assume you owe $5,000 on your auto loan with an interest rate of 9.9% and another $5,000 on a personal loan with an interest rate of 14.9%. The math dictates which loan to pay off first. Eliminate the higher interest rate. This same reasoning could be applied if you had a credit card balance of $5,000 with a 22% interest rate.

If the car loan carries the highest interest rate, this argument would dictate that you pay that first, but interest is not the only factor involved. Early payoffs on car loans sometimes come with early payoff penalties. If the auto loan has that provision built in, paying off the personal loan first might be the more cost effective option.

Prioritizing bill payments by interest rate is not a new concept. The debt avalanche philosophy suggests you prioritize your debts in order (high to low) by interest rate. What it does not account for is early payoff penalties. Check the terms and conditions carefully before adding an auto loan or pre-qualified personal loan to a debt avalanche program.

Refinancing vs Early Payoff of Your Auto Loan

If your goal is to lower your monthly debt payments, refinancing might be a better option than an early payoff. It’s the same process you would go through to refinance a personal loan. The objective is to lower your interest rate and stretch out the payment terms, so your monthly payment goes down. This gives you more available spending power each month.

Be deliberate when you shop for a loan to pay off debt. Each application you submit could result in the lender doing a “hard inquiry” on your credit report. Each of those inquiries drops your credit score a few points. The loan itself will also add more to the “amounts owed” category used in calculating your score, but that can be offset by paying off the car loan.

Use Your Savings to Avoid Financial Unmanageability

Assuming that there are early payoff fees or that you’ll still save money even if you pay those fees, using your savings to make the final lump-sum payment will help you avoid financial unmanageability. If you don’t have enough in your savings account to cover it, you might want to rethink an early payoff. Save a few more dollars before you do it.

It’s also important to note that an early payoff of your auto loan doesn’t need to happen in one big payment. Many borrowers choose to make extra or double payments each month to shorten the term of the loan and save on interest payments. Check your terms and conditions to see if that’s allowed without incurring any extra penalties.

FAQs

It’s not bad to pay off a car loan early because that will be one more debt payment you don’t have to make each month. There may, however, be an early payoff penalty.

No, paying off your car should raise your credit score, though it may not happen immediately. Your credit score may drop temporarily immediately after the payoff, but it will go back up again in a few months.

A few ways you can pay off your car loan faster include paying twice a month instead of once a month, rounding up your payments to pay a little more than what is owed, or making one large extra payment each year. In some cases you may want to refinance for a lower rate or use your tax refund. You should also avoid missing payments, and if you can, freeze extra spending and put all extra cash toward the debt.

Learn more: How to Pay Off Your Car Loan Faster?