When you’re in a financial situation that allows you to pay off your car loan early, you might be able to save big on interest. But that’s not always the case. There are a few of factors to consider before you jump in.
Should I pay off my car loan early?
You might want to consider paying off your car loan early if you’re interested in saving on interest or getting out of debt quicker. There are three main situations where you can benefit the most from repaying early:
There’s no prepayment penalty. Some lenders charge a prepayment penalty to make sure they don’t lose the interest you would have paid. You often can’t save if there’s a prepayment penalty.
Interest isn’t precomputed. Some lenders front-load the interest charge, meaning you’ll pay the same amount no matter how quickly you pay off your loan.
You don’t have higher-interest debts. If interest rates are adding up more rapidly on another comparably sized debt, focus on prepaying that first.
Can I pay off a car loan early?
You can, though how it works depends on your lender. You can either make multiple additional repayments toward your loan. Or you can make a large one-time repayment to pay it off all at once. Reach out to your lender’s customer service department to learn about your options.
How much you can save depends on several factors, including how much time you have left on your term, your loan balance and your interest rate. Use our car loans calculator to learn the difference between repaying your loan according to your current term and paying it off early — if you have no prepayment penalties.
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 it at all.
Repaying fixed- vs. variable-rate loans
Your options might vary depending on the type of interest rate you have.
Repaying a variable-rate loan. Lenders generally place fewer restrictions on car loans with variable interest rates. Since lenders generally don’t lose much money from early repayment, you likely won’t have to worry about early termination fees.
Repaying a fixed-rate loan. Repaying your entire loan involves paying whatever 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.
How can I pay off a car loan early?
You have a few different option to choose from when you want to pay off your car loan balance early:
Refinance your loan. If you find yourself in a better financial position with a strong credit score, you could refinance your car loan to get a shorter term with better rates, paying off your debt in a fraction of the time.
Make additional payments. If allowed, try to make additional payments whenever possible. Making payments every other week adds one extra payment at the end of the year, helping 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 pay raise.
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 and put it toward your car loan.
Sell your stuff. Make a list of personal items that you haven’t used in a long time and determine if you need them anymore. You may find that they’d be better as cash in your hand than taking up space in your home.
Don’t skip payments. Even if you don’t owe any interest right now and don’t need to make a payment, it’ll still add up and could cost you more money.
What else should I know about car loan payments?
Your car loan terms will affect how you make repayments, so examine them carefully, including:
Many lenders precompute interest on your car loan. Also known as add-on interest, this means the amount of interest you’ll pay by the end of your loan is worked into your payments. Even if you make extra payments, 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.
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 precomputed interest, you should know how those additional payments are applied.
Payments are usually drawn out of your bank account with autopay, but you may be given other options to pay off your loan. However, these may come with extra fees, which could make your loan more expensive.
Watch out for the Rule of 78s
Some lenders, particularly from buy-here-pay-here lenders, offer loans with a precomputed interest rate using what is known as the Rule of 78s formula. These loans front-load interest so that borrowers pay around two-thirds of their loan’s interest in the first few months.
In some states, it’s illegal to use the Rule of 78s to calculate interest on car loans with a term of five years or less, including:
Making additional payments on your car loan 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. It’s a good idea to specify with your lender that you’d like the money to go toward your balance whenever you make an extra repayment.
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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