Paying Off a Car Loan Early: Fees, Penalties, and Next Steps

There are many benefits to paying off a car loan early. You can save on interest, get out of debt sooner, and own your car outright faster. You’ll also free up room in your budget. But while an early payoff is typically a good thing, occasionally there may be a downside. 

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One of the potential disadvantages of paying off a car loan early is if you have an early prepayment penalty. It means you’ll owe the lender a fee for paying off the loan before it’s due. Prepayment penalties are rare, but it’s worth checking whether your loan has one.

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Key takeaways

• Prepayment penalties are a fee charged by your lender for paying your car loan off early.
• It’s relatively rare to see prepayment penalties on today’s car loans, and they are prohibited altogether in several states.
• If your current car loan does have a prepayment penalty, it might still be worth it to refinance or pay it off early if the savings outweigh the fee.

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What is a prepayment penalty on a car loan?

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A prepayment penalty is a fee your lender charges for paying off your loan in full ahead of the expected payoff date. It’s a cost you pay in addition to the principal amount borrowed and the interest. 

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The average penalty cost for paying off loans early is usually 1% to 2% of the outstanding balance, a fixed amount that’s the same for everyone, or equal to a set amount of interest.

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Prepayment penalties aren’t common with most modern car loans, which use simple interest. As you pay down your balance, the interest shrinks, too, because it’s based on the remaining principal. You’re more likely to see a prepayment penalty with particular loan structures, like precomputed interest loans. Those calculate the interest ahead of time and spread it across every payment, so you can’t save money by paying the loan off early.

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Not only are prepayment penalties relatively rare on car loans, they may not even be allowed, depending on your state and the type and length of your loan. Some states, like Maryland, prohibit lenders from charging any prepayment penalties at all. 

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How to tell if your car loan has a prepayment penalty

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While it’s unlikely that your car loan has a prepayment penalty, you should check to make sure. Owing a prepayment penalty could change your calculations on whether you want to pay off your car loan early.

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Here’s how to find out:

• Call your lender: Request a payoff statement and get the fees and payoff amount in writing. You can use that information to prepare for your loan payoff, too.
• Check your loan paperwork: Look for the terms “prepayment penalty” or “early payment clause” in your Truth-in-Lending Act documents, promissory note, or loan contract.
• Check your state’s laws: Find out whether your state allows or prohibits prepayment penalties.

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Can you pay off a car loan early even with a penalty?

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You might still pay off a car loan early, even if there’s a prepayment penalty. But you’ll need to calculate whether the cost of the penalty is worth it.

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Here’s an example. Suppose you have a $30,000 car loan with $15,000 remaining. There is a prepayment penalty of 2% of the outstanding balance, or $300. You want to pay the loan off early, whether in cash or through the auto refinancing process. If doing so saves you $1,200 in interest, then you’d come out $900 ahead. 

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If the prepayment penalty is steep, there could be other ways to pay down the loan faster. Ask the lender whether you can apply additional payments to the principal, instead of toward future interest. It might help to bring the balance down more quickly without triggering a prepayment penalty.

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How to avoid prepayment penalties on car loans

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Even though prepayment penalties aren’t common, they do appear from time to time. It’s a good idea to keep an eye out for them when loan shopping, whether you’re buying a new car or exploring your auto refinancing options. 

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Here’s how to avoid prepayment penalties on car loans:

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• Restrict your search to loans without prepayment penalties: Focus on lenders that clearly state up front that they do not charge this type of fee.
• Discuss fees and penalties during the application process: Lenders are required to be transparent about borrowing costs and provide a list of fees and charges.
• Negotiate the removal of a prepayment penalty, if there is one: Many aspects of your car loan are negotiable, including prepayment penalties. 
• Ask for a different type of loan: If the lender doesn’t want to remove the prepayment penalty from one particular loan, ask them if they offer other options that don’t have that penalty included in the terms.

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Refinancing for an early payoff

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Refinancing is a common way to pay your auto loan off early. It can help you save money by lowering your interest rate or shortening your repayment period. If your current loan does have a prepayment penalty, it could still be worth it to refinance if the savings outweigh the penalty amount.

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RefiJet offers tons of resources to help you find the best refinancing options for your goals and current budget. Use our auto loan refinancing calculator to see your potential savings, and learn more about auto refinancing requirements with our helpful guide. 

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FAQs

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Below are some of the most frequently asked questions about the prepayment penalty on a car loan.

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What is a prepayment penalty on a car loan?

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A prepayment penalty on a car loan is the fee a lender charges for paying the loan off before the payoff date. This fee is prohibited in some states, and may be a percentage of the outstanding balance or a fixed fee. Prepayment penalties are fairly rare on car loans.

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How do I know if my auto loan has a prepayment penalty?

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Auto loan prepayment penalties are relatively uncommon, but it’s still smart to check. You can call your lender and ask, check your loan documents for applicable fees and charges, or request a payoff amount in writing, with fees included. 

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How is an auto loan prepayment penalty calculated?

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There are a few different ways that auto lenders calculate prepayment penalties. One way is by multiplying the outstanding balance by a percentage, such as 1%, that is listed in your contract. Another way is to charge a fixed amount. Still others charge an amount equal to a set number of months' worth of interest.

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Should I refinance instead of paying off my car loan early?

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Refinancing your auto loan may be the better option if you can qualify for a lower interest rate, meaning you could pay less in interest. It’s also preferable if you don’t have the cash on hand to pay off the loan in one lump sum. Paying off the loan early could be better if you want to be debt-free and can afford to spend the money to do so without jeopardizing your savings.

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Is there a penalty for making extra principal payments each month?

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In most cases, there’s no penalty for applying extra payments to your principal each month. In fact, it can usually help pay the loan down faster. Check with your lender directly to make sure any extra payments will be applied to your principal and whether there is a penalty for doing so.

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