Should You Pay Off Your Car Loan Early? 3 Pros and Cons
Written by
Cynthia Measom
Edited by
Rebekah Evans
Commitment to Our Readers
GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.
20 Years
Helping You Live Richer
Reviewed
by Experts
Trusted by
Millions of Readers
When you have some extra cash, it can be tempting to knock out debt — especially if it would put an end to a large monthly obligation, like a car payment. But is it the right move?
Below, Ashley Morgan, attorney and owner at Ashley F Morgan Law, PC, explained the pros and cons of paying off your car loan early.
Also here are the biggest money mistakes when buying a car.
Pros
Limits the Amount of Interest You Pay
Morgan said the quicker you pay down the principal of the loan, the less interest you’ll pay overall. She explained that most car loans are also simple interest loans, which means straight interest calculated monthly or daily. So as it is paid down, she said, it is less interest.
Limits Your Risk
Morgan said that whenever there are loan payments, there’s always a chance something could go wrong, such as missed payments from a loss of income or human error. Another concern is if the car is damaged or totaled.
“While insurance typically covers the value of the car, if you owe money on the car, owing more than the car is worth is always a concern,” she explained.
However, she said, paying off the loan early removes those risks and it also prevents any negative equity — owing more than what the car is worth — from carrying into a future car purchase.
Lowers Your Debt-to-Income Ratio
“Paying off your car early also can lower your debt-to-income ratio,” Morgan said. “If you are buying a house or another large transaction, having a lower amount of debt is ideal.”
Cons
Possible Credit Score Decrease
Morgan said that it’s possible your credit score might drop once you pay off your car. However, she added that this is usually a limited drop and typically temporary.
According to Experian, if your credit score decreases in this instance, it should rebound within a few months as long as you don’t have other negative items present.
Funds Might Be Better Spent Elsewhere or Saved
Another con, according to Morgan, is that the funds you use to pay off your car might be better spent alternatively or used as an emergency cushion. She said it’s important to have a decent emergency fund for any financial issues that arise in the future.
“For some people, there is also the opportunity cost of using their cash to pay off the car early,” she explained. “Car loans are typically at lower interest rates, so it can make sense to pay off credit card debt first. Similarly, some people with lower interest loans would rather use cash on hand to invest.”
Penalties or Limited Savings
Morgan advised checking to see if your loan has a prepayment penalty that will cost you additional money to pay off the debt. Per Experian, you can expect to pay around 2% of the outstanding balance.
She also explained that most car loans are also simple interest loans, which means straight interest calculated monthly or daily. However, she said that some car loans have interest front loaded or the full finance fee is embedded into the loan, so paying off the loan early won’t save you any money.
