Paying off your car finance early

There could be a number of reasons for wanting to end your car loan agreement early. You might no longer need your car, for instance, or maybe the cost of your monthly payments has become too expensive. But before you do anything, 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 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 largely depends on the interest rate you were offered when you negotiated the loan and on the settlement figure you’ll have to pay 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. 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 2 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 – although you also won’t get anything back.

However, you’re only legally entitled to this if you’ve already paid off half 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), you’ll usually only have paid off half the overall cost towards the end of your loan.

Voluntary termination and returning the car 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 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 it’s worth more than you’ve paid for it.
• Keep it. If you still want the car or 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 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.

If you haven’t paid off at least half of the loan before you want to end the contract, there’s also the option to pay what’s remaining of the 50% and return the vehicle.

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, although this can’t be charged if you’re only making an early repayment of £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 2 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

Pros and cons of repaying your car loan early

Things you should be aware of

Before choosing to end your car finance agreement early, you should keep the following in mind:

• How often are you using voluntary termination? Using voluntary termination to end your agreement early will show up on your credit file. This won’t directly affect your credit score, and there will be no record of why you ended the agreement. However, if you use this method regularly, this can look bad to car finance companies. Lenders tend to be wary of people who often use voluntary termination to end an agreement, as it can be costly for them.
• Are you applying for another car finance agreement? If you end an agreement and apply for another one, another credit check will be carried out, which can affect your credit score.
• Are there early repayment fees? It’s important to work out how much these will cost you to check whether it’s definitely cheaper to pay off the loan early rather than continuing with your repayments.
• How close are you to the end of your agreement? If you’re near the end, it could be cheaper to continue to make your monthly repayments rather than repay the loan early and pay an early repayment charge.
• Are you in negative equity? If the remaining amount you need to repay is more than the value of your car, this is known as negative equity, and you’re probably better off continuing with your repayments.

When is the best time to end your finance deal?

Some sensible reasons for repaying your finance deal early include:

• You have the money to pay off the loan early and want to reduce your monthly outgoings.
• Paying off the loan early will be cheaper than continuing with your repayments.
• The value of the car is higher than the remaining balance – in this case, it could make sense to pay off the settlement figure and sell the car.
• You want to own the car outright.

How to pay off your car loan early

There are a number of different ways to pay off your car loan early. These include:

• Increase your monthly repayments. If you can afford to, ask your finance company if you could make 2 payments a month, as this will help you clear the debt faster and save you interest.
• Make a one-off larger payment. If you can’t increase your payments regularly, consider paying a larger lump sum every time you can afford to.
• Refinance your loan. If you have a good credit score, you might be able to refinance your car loan to a cheaper rate of interest and/or a shorter term.

Bottom line

There are a number of reasons why it can make sense to pay off your car finance early, but it’s important to factor in early repayment charges and consider whether it will definitely save you money in the long run before you commit.

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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.