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Paying off your car loan early can reduce the interest you pay and free up some cash each month for other priorities. However, there may be some downsides you should consider. We’ll explore the pros and cons below to help you decide if you should pay off your auto loan early.
Paying off your car loan early could save you money over the life of the loan. Here are some of the primary benefits of an early payoff:
Settling your debt early can reduce the total interest you pay over time. Most car loans use simple interest, where the interest is calculated based on the remaining principal. Paying extra each month reduces the balance faster than your original loan payment plan, shortening the repayment timeline. For every month you shave off your loan, that’s a month’s worth of interest you won’t have to pay.
For example, say you borrowed $28,000 at 7% interest. You have 48 months remaining on a 60-month loan. Your regular monthly payment is $554, and the overall interest owed would be $5,266. Paying an extra $50 a month would speed up the rate you pay off the principal, paying off the loan four months faster. Without those last four months of interest, you would save $332 in interest payments.
An early payoff could lower your debt-to-income ratio (DTI), a critical factor in credit scoring. Lenders use DTI to estimate your ability to manage monthly payments to repay money you plan to borrow. Lowering this ratio may improve your financing options for mortgages or other loans.
Once your car loan is paid off, you’ll no longer have that monthly payment to worry about.
This increased cash flow may provide you with more opportunities to save, invest, or reduce your other debts, depending on your goals.
Using our loan example above, you could put the $554 you would have put toward your car loan into a high-yield savings account each month, where it can earn interest. Or if you have an outstanding balance on your credit card or other high-interest debt, you can apply an additional amount toward paying it off. You could even funnel that money into a brokerage or retirement account to save for the future.
Paying off a car loan early means you get full ownership of your vehicle sooner. When you own your vehicle outright, it increases your options and gives you more flexibility, since you’re not tied to the car loan. You could trade in the car for something else or sell it to recoup some cash.
Paying off your auto loan early also allows you to make decisions about your car without the burden of debt. For example, when you have a car loan, you’re often required to pay for full coverage car insurance. But if you own the vehicle outright, you have the option to choose the level of coverage that’s best for you, which might be a lower level than what the lender would require.
If your car’s value drops faster than you pay down the loan, you risk becoming "upside-down" — owing more than the car is worth. This can make it difficult to sell or trade in because you’d need to pay the difference in equity between your car and your loan. Early repayment could help you avoid this scenario.
It’s also important to know the potential disadvantages of paying off a car loan early. These include:
Some lenders might have fees for paying off your loan early. These fees may reduce the financial advantage of an early payoff, so make sure to check your loan terms before acting.
Before deciding if you should pay off your car loan early, think about whether there may be a better use for that money.
For example, car loans usually have lower interest rates than credit cards, so you might save more money if you pay down your credit card debt first.
Also, if you pay off your car loan early, you might not have enough cash left over to cover emergencies like an unexpected medical bill, car repair, or job loss. If paying off your car loan means you’d have to rely on credit cards in an emergency, it may not be the wisest decision. Consider your bigger financial picture before committing to an early payoff.
Eliminating debt generally benefits your finances. However, paying off a car loan early might lower your credit score in the short term. This can occur due to a change in your credit mix — lenders like to see a variety of credit types such as mortgages, car loans and credit cards. In most cases, credit score dips after paying off a loan are temporary.
Ask yourself some key questions to know if paying off an auto loan early is the right choice.
It can make sense to pay off a loan early if:
Paying off your car loan early is not always the best option, especially if the money could be put to better use. You shouldn’t pay off a car loan early if:
It’s important to consider both the costs and benefits to determine whether early payoff will help you achieve your financial goals.
If you choose to pay off your car loan early, there are a few different ways you can go about it:
If you’re still deciding whether you should pay off your car loan early, refinancing may be an alternative way to save. Refinancing lets you get a new loan that might better fit your current situation.
For example, getting a car loan with the same term but a lower interest rate may lower your monthly payments. By paying the same amount as before your refinance, you could pay down the loan faster and save on interest. You can use a refinance savings calculator to help you choose whether you should pay off your car loan early or refinance instead.
Like paying off your loan early, consider the pros and cons of refinancing before you take action. Learn more about the auto refinancing process and whether it’s right for you by visiting our guide on how to refinance a car.
Here are some common questions about paying off car loans early to help you make informed decisions.
You may be able to lower your total interest costs and free up cash flow by paying off your loan early. If you don’t have high-interest debt to tackle first, and paying off the loan won’t drain your savings, it could be a smart idea.
Paying off your car loan early may temporarily lower your credit score. This occurs because an early payoff can reduce your credit mix, which is a key factor that lenders consider. However, the long-term advantages of reducing your overall debt typically outweigh any short-term impacts on your credit.
Some lenders might charge prepayment penalties for settling a car loan early. These fees vary by lender, loan type and state law, so review your loan agreement before acting. If penalties apply, consider the costs versus the benefits of paying off the loan early.
Yes. Most car loans have a simple interest rate, so paying it off early will decrease the interest you owe. You can use an auto payment calculator to see how much you could save.
Some lenders might charge prepayment penalties, but many don’t. Check your loan agreement to be sure. Some common ways people get out of a car loan early include selling or trading in the vehicle to pay off the loan, making extra payments or refinancing for more favorable loan terms. Some lenders may allow loan assumption, which lets another person take over your payments.
Find out how to refinance a car loan, from checking your credit to signing new paperwork. Learn when it makes sense and how to avoid common mistakes.
