Why Paying Off Your Auto Loan Early Doesn’t Always Save Money

Paying off your auto loan on time and in full is definitely not a bad financial move. With timely payments, you can keep your credit healthy, plan your budget month-to-month and prove that you can keep a deadline.

And if you’re impatient, ambitious, newly minted or some combination of the three, paying off a car loan early is a perfectly acceptable (and allowable) option. But paying an auto loan off early doesn’t necessarily mean you’ll save money. There are a few pros and cons depending on your financial situation.

How to Pay Off a Car Loan Faster

Paying off a car loan early requires you to finish reimbursing the amount owed to your lender before the agreed-upon final payment date. So, if you took out a loan for 60 months (five years), but you finished paying what you owed in 36 months, you’ve paid your lender, in full, two years early.

Here’s an example of how to pay off a car loan faster, using an online early loan payoff calculator:

  • Your original loan balance is $15,000
  • Your annual percentage rate (APR) is 2.50%
  • Your loan term is for 60 months
  • You’ve already completed 36 months of payments
  • You’re willing to increase your monthly payments by $500 a month toward your principal

According to the calculator, following this schedule will let you own your vehicle 1.3 years earlier than planned (in seven more months vs. two years), saving you $103 in interest per month, or $1,751 in total interest.

It sounds simple, but there are some financial factors — and challenges — to consider.

Read: How These 5 Personal Finance Experts Financed Their First Cars

When You Should and Shouldn’t Pay Off a Car Loan Early

Are you really saving money by paying that loan off early? When it comes to simply interest, yes. Your principal is fixed.

If the loan is valued at $20,000, you’ll owe $20,000 no matter how long it takes to fulfill your loan. But your APR is tacked on to the principal — the longer you take to pay the loan, the more interest you pay. The quicker you pay it off, the less interest you owe. If it’s precomputed, then the interest is fixed to each monthly payment. Before signing the paperwork, double check which type of interest you’ll owe.

That doesn’t mean you should scramble to pay off your car loan at any cost, however. There’s a time and a place for everything, and that includes paying off a loan.

When You Should

You have a large emergency fund. Whether you’re an ace at saving,  you’ve managed to consolidate your bills or you know how to cancel unnecessary expenses, if you have a surplus of funds available, using that to pay off your auto loan gives you more debt-free life out of your car and more time to save up for your next car in the interim.

You care about your credit score. By paying down and paying off your loan sooner, you show good creditworthiness and spend less time in debt, which makes a difference when it comes to FICO scoring and debt-to-credit ratio.

You’ve been able to refinance. If you started at a 5 or 6% interest rate but refinanced a few years ago to a 1 to 2% APR, your standard monthly payments are lowered. That can give you more leverage toward paying off the car.

When You Shouldn’t

You’re strapped for cash. If you have limited funds or income, or you’re in debt with a mortgage, school loan or credit card, don’t struggle to pay off your car early, especially if your auto loan interest rate is lower than the rate of these other debts. In this case, speeding up your payment time could cause you to go further into debt. Also consider if your auto loan is more car than you can afford.

You might incur a penalty fee. Car dealers make their cash off interest. Thus, many lenders will impose penalty fees to borrowers who pay off their loans early to make up for the interest payments they’re not receiving.

The Golden Rule Is Don’t Be Late

If you’re confident you can pay off your car loan early, and you don’t foresee any financial roadblocks getting in your way, go for it. Paying off your auto loan quickly can be a boon to your finances, freeing up money not only toward your next car or other expenses.

But if the challenges of paying down an auto loan early outweigh the benefits, don’t spread your finances too thin. The most important thing to consider with an auto loan is paying it off on time and in full. Don’t feel pressured to race your debt to the finish line.