Paying off your car finance early

When you bought your car three years ago, you thought it was the most comfortable on the market… but three years later, those seats are just killing your back. Or maybe things have changed, and you’re not meant for each other anymore, now that you have a wife and a couple of kids.

There may be a million reasons for wanting to end your car loan early and, depending on which applies to you, you’ll have to figure out if it’s really the best option for your finances. To begin with, here’s a little compendium on what you can expect if you do decide to go through with it.

Should I pay off my car loan early?

Yes, no, maybe? Well, it can depend on a number of factors. You can start by thinking about the following:

• How much it will cost. In most cases, you’ll need a solid chunk of money to pay off the loan early, so the first step is figuring out if you can afford to spend that much in one go.
• How much you can save in the long run. This will largely depend on the interest rate you were offered when you negotiated the loan, and on the settlement figure you’ll have to pay to your lender to walk away.
• The reason why you want to change the car. If things get really expensive, you should consider whether it’s worth it or not. If you’re changing the car because you don’t like it anymore, maybe you can hold on for another couple of years until the loan comes to its natural end. Conversely, if the car is now way too small or too big for your needs, it may be worth the investment.
• How much your car is worth. Are you going to pay more or less than it cost? Will you be able to sell it afterwards?

Ending personal contract purchase (PCP) early

You have two main ways of getting out of a PCP deal:

Ending PCP through “voluntary termination”

This can be a solution if you can’t afford the payments anymore and can do without the car. It allows you to return the car and walk away without paying any extras.

However, you’re legally entitled to this only if you’ve already paid off half of the overall cost (which includes the car value plus interest and fees). This clause can be a lifesaver if you’re experiencing financial difficulties, but unfortunately it doesn’t apply in a lot of cases. Because of the way PCPs are structured (with a fairly big balloon payment at the end if you want to keep the car), usually you’ll only have paid off half of the overall cost towards the end of your loan.

Voluntary termination is also a better option if the car has depreciated more than expected and you don’t want it anymore. That’s because if you pay off the whole sum early instead, you’ll end up becoming the owner of a car that’s worth less than you’ve paid for.

Paying off PCP early

If you have quite a chunk of money to invest in this, it’s a viable option. You can get in touch with your finance company and ask for a settlement figure to terminate your loan. The settlement amount will include all the money you still owe, plus (in many cases) a fee to compensate the company for the interest you’d have paid if you continued the loan. You’ll also need to cover the balloon payment.

Once you’ve paid the whole sum, you’ll become the owner of the car. You can then:

• Sell it. If it doesn’t suit your needs anymore or if it’s worth more than you’ve paid for it.
• Keep it. If you still want the car or if you can’t get a good deal by selling it.

Ending hire purchase (HP) early

With HP, your options are similar to what you can do if you want to end a PCP deal.

Ending HP through “voluntary termination”

Just like with PCP, you can return the car and walk away without paying anything more if you’ve already covered at least half of the overall cost.

The main difference is that HP doesn’t entail a balloon payment and comes with higher monthly payments, so you’ll usually reach that point earlier. Moreover, with HP you borrow more money than with PCP, so if you return the car early you’ll save more on interest.

However, keep in mind that if you’ve already paid back more than half of the car’s value (which is more likely to happen with HP), you won’t be entitled to compensation.

Paying off HP early

Similarly, if you have a lump sum to invest, you can pay off your HP and become the owner of the car. Your settlement figure will be the outstanding amount of the loan plus a fee, which can’t be charged if you’re only repaying early £8,000 or less. If you’re repaying more, the fee is capped to the lower between:

• 1% of the amount paid early (or 0.5% if you’ve entered the last 12 months of the loan).
• The remaining interest.

If the lower of the two is the remaining interest, you won’t have saved any money by paying off the loan early. Like with PCP, once your debt is settled and you’ve effectively bought the car, you can either keep it or resell it, depending on its value and your needs.

Dos and don’ts

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Frequently asked questions

• Are there any penalties for paying off a car loan early?

  Unfortunately, it really depends on your lender. With HP, the extra fee you can be charged is capped by law, so it isn’t too exorbitant and in many cases should be less than the remaining interest you have to pay. However, that isn’t the case with PCP, and paying it off early may not be a great financial win, even if you sell the car for a good price afterwards.

• Does paying off a car loan early hurt your credit score?

  No, it doesn’t. However, keeping it open may improve it more, especially if you don’t have many other forms of credit (credit cards, a mortgage and so on). Having a loan and making all the payments on time will usually be more beneficial for your credit score than paying it off.

• Do you save money if you pay off a car loan early?

  That’s the million dollar question. You may save money on interest if you pay off your loan early, but it depends on the settlement figure you’ll be offered. You’re more likely to save some money if you’ve bought your car on HP than on PCP.