When your financial circumstances allow you to pay off your car loan early, you might be able to save some serious money on interest. But that’s not always the case. There are a few of factors to consider before you dive into an early repayment scheme.
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It depends on your lender, but usually you’re allowed to pay off your car loan early. Doing this can cut down on the total cost of your car, because there’s less time for interest to compound on your loan.
However, some car loans are calculated with pre-computed interest, which means you pay the same amount of interest if you discharge the loan early as you would’ve paid had you stuck with the original loan term.
Loans with pre-computed interest ensure that lenders get their full interest payment, regardless of how soon you choose to pay off your loan. In these cases, early repayment can only get you out of debt faster, but it won’t cut down on the cost of your car.
7 strategies for paying off your car loan early
Refinance your loan. If you find yourself in a better financial position than when you bought your car, and you have a strong credit score, you could refinance your loan to get a shorter term with a better rate, which will help you to pay off your debt faster.
Make additional payments. If allowed, try to make additional payments whenever possible. Making payments every other week, as opposed to twice a month, adds two extra payments per year (you’d make 26 payments instead of 24), which will help you save on interest.
Make lump sum payments. Try to make a few large payments per year when you get extra cash from a bonus, tax refund or a pay raise.
Get a side gig. Working a few extra hours on the side can help you save up the cash you need to pay off your car early. Even small savings can really add up.
Renegotiate your car insurance. There could be additional savings if you start comparing other car insurance options, especially if you have a record of good driving. Then just apply the money you save to your car loan.
Sell your junk. Make a list of personal items that you haven’t used in a long time and decide if you really need them anymore. You may find that they’re better used as cash in your pocket than as junk items taking up space in your home.
Don’t skip payments. Even if, according to the terms of your loan, you don’t owe any interest right now and don’t have to make a payment, never skip one! Missing one of your scheduled payments will delay the repayment of your loan and may cost you more money in the long run.
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How do early repayments work?
Before you take out a car loan, check with the lender to see what penalties or fees it charges for early repayment. Many car loans use your car as collateral and come with a fixed interest rate. In this case, lenders might place restrictions or fees on early repayments or won’t allow you to repay the loan early at all, because they would otherwise lose money on interest payments.
There are two different approaches to making extra payments or paying your loan off early:
Repaying a variable-rate loan. Lenders generally place fewer restrictions on car loans with variable interest rates. Since lenders generally don’t lose as much money from early repayment with variable rate loans (as opposed to fixed rate loans), you likely won’t have to worry about early termination fees.
Repaying a fixed-rate loan. Repaying your entire loan involves paying whatever the loan balance is due to the lender during a fixed-rate period. Here you’ll likely pay termination and administration fees that the lender uses to cover its lost interest.
What else should I know about car loan payments?
Your car loan payments will affect how you deal with your loan, so examine them carefully. Before you send a new loan application, make sure you’ve considered the following factors.
Many lenders pre-compute interest on your car loan. This means that the amount of interest you’ll pay by the end of your loan is worked into your payments. Even if you make extra payments, the bulk of it will likely be applied to your interest — not the principal — so you won’t reduce the actual amount of your loan.
Lenders usually give you the option of making payments weekly, twice a month or monthly. This can help you figure out a budget. If you’re paying a variable interest rate, you should also know when the lender recalculates your interest according to the prime lending rate.
Check if you’re able to make additional payments without penalty or if there’s a cap on how many additional payments you can make. And like with pre-computed interest, you should know how those additional payments are applied.
Most people prefer to set up their payments to be automatically withdrawn from their bank accounts, and some lenders may actually require this. You may be given other options to pay off your loan, such as through an online account with your lender or paying by cheque. However, these comes with extra fees, which could make it more difficult to reduce your balance owing.
Bottom line
Making additional payments on your loan can be a helpful option that can help you save down the road, but it’s not the only feature that lenders have to offer — and it’s not always guaranteed to save you money. Remember to compare car loans, taking into consideration fees, features and rates to find the right one for you.
Frequently asked questions
It depends on your lender. Sometimes only part of an extra car loan repayment goes toward the principal and the rest may be applied to interest. It’s a good idea to specify with your lender that you’d like the money to go towards your balance.
Closing your car loan can affect your credit utilization ratio, one of the many ways credit bureaus determine your credit score.
Even though there may be a prepayment penalty, paying off the loan early will typically be cheaper then the interest acquired in the long run.
Unless stated in your contract, you should be able to refinance your loan whenever you like.
Matt Corke is Finder's head of publishing for rest of world and New Zealand. He previously worked as the publisher for credit cards, home loans, personal loans and credit scores. Matt built his first website in 1999 and has been building computers since he was in his early teens. In that time, he has survived the dot-com crash and countless Google algorithm updates.
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