When you pay off your car loan before the end of its term, you can eliminate your monthly debt payments faster. The idea is enticing, but it’s a decision that requires careful consideration. Paying off car loans early is not for everyone. It depends on a variety of factors, including the interest rate and monthly payments. Of course, you have to determine whether you can afford to pay your remaining balance in full.
For some people, paying off car loans is worth it. However, it may not be for you. First, you have to assess your situation before you make the jump.
Let’s examine the pros and cons of paying off your car loan early.
The Benefits of Making Early Car Loan Payments
If you have evaluated your finances and learnt that you could pay off your car loan before the loan term, you could reap some benefits:
- You Can Improve Your Debt to Income RatioThe debt you owe compared to the amount you earn is your debt to income (DTI) ratio. Many lenders look at this number for specific reasons. Your DTI tells them that it’s easier for you to pay off your car loan, which also simplifies the process of taking out your next loan if you wish to do so. Eliminating your car debt can help improve your DTI ratio.
- You Get to Save MoneyWhen you pay off your car loan each month, the payment goes to your principal or the original borrowed amount. Additionally, it goes to your interest rate. So, when you pay extra, you’re not only paying the borrowed money, but you also lower the loan’s interest over the loan period.In line with saving money, you get to free up some of your cash so that you can use it for other expenses. You also effectively lower your car insurance payments. As a result, you have some money that can go to your savings account, spend it for a rainy day, or pay off other debt.
- The Car Is YoursYou already bought the car after getting the loan, which makes you its owner. However, what if you fail to make your monthly payments? The lender can take the car from you as payment for the amount you borrowed. If you pay off your car loan early, you do not have to worry about your lender and their right to take the car for payment delinquencies. Remember that even though you’re the person driving and maintaining the vehicle, it still does not belong to you so long as you have not cleared the loan on it.
Freeing yourself from the car loan means you’re the owner of the car. You can sell it and earn from the sale. Some lenders may allow you to sell the car if you can no longer repay the loan. But you do not get to keep the proceeds of the sale, which will go to the lender.
The Downsides of Paying Off Car Loans Early
As you can see from the previous section, there are indeed a few good things that you can enjoy if you choose to pay off your car loan early. But it’s vital that you also know it has some disadvantages:
- You Could Be Charged With Prepayment PenaltiesBefore you pay off your loan before the end of its term, you should first check the loan’s policy. Does it state that it comes with prepayment penalties? If so, you could face a hefty fee should you decide to pay off the loan before the term is up. Many lenders are not keen on their borrowers terminating the contract early, which is why they have a stipulation preventing you from making additional payments.Some lenders are fine with early repayments, but you may still have to wait at least a year before you can pay it off. Despite this ability, there could be certain conditions that you have to meet to qualify. Before you pay off the balance of your car loan, be sure that you read your contract well. You should also contact your lender for confirmation.
- You Might Need the Money for Other ExpensesSure, paying off your car loan means that you have a good chunk of extra cash in your wallet. But if you have other debts or expenses at the moment, it’s probably better if you put in that money elsewhere. Suppose you have another financial obligation that costs you more each month. In that case, you might benefit more if you pay that one first.If you have two or more loans, pick the debt with the highest interest rate and increase the monthly payments you put into it. Doing so will help you save more on the total interest you owe.
- Your Credit Score Could DropPaying off debt means that your total credit dips, which affects your credit score. Some lenders take credit scores seriously.But don’t let the lower score discourage you. The drop is temporary, so your credit score will increase, usually in a few months.
Considerations for Paying Off Your Car Loan Before the End of the Loan Term
If you’re planning to pay off your car loan early, always look at the possible penalty fees you could face. Compare the cost of the charges to the savings you could gain if you repay your debt sooner. If you see that the penalties are more than the amount you can save, it is better to follow the schedule of monthly repayments.
Paying off your car loan is best if you can pay it off in full. You can also choose to make a partial payment if you got a bonus at work or perhaps you sold something that gave you extra dollars. Another option is to simply boost your monthly payments to help reduce the amount you need to repay your car.