Getting your car loan paid off quickly may seem like an easy call to make. Lowering your monthly payment is enticing.
However, in some cases, it may attract a prepayment penalty, a fee charged for paying a part of or full loan amount early.
According to Lantern by SoFi, ”when you pay off your car loan early (before your loan term is up), your lender doesn’t earn as much money on interest as it would if you paid it off according to schedule.
So in some cases, it may use a prepayment penalty to disincentivize you from paying the money back early and to help it make up for lost revenue.”
Before you rush to pay off your car ahead of schedule, however, it’s important to consider both the risks and benefits of this decision.
Pros and cons of paying off your car loan early
There are many benefits to paying off your car loan ahead of schedule. These include:
- Money saved on interest: Paying an additional portion of your auto loan each month may reduce the total interest paid on the loan. Be aware, however, that this is not true in all cases. For example, paying extra each month will not reduce the total interest owed if you have a fixed interest loan. Make sure to read and understand the terms of your loan before you accelerate payments.
- The extra money available in your monthly budget: When your car is paid off, you can take the extra cash and use it to pay off other debt, invest or save, or use it for a nice vacation, to buy a new computer or anything else you like.
- You won’t pay more for your car than it’s worth: Since most cars depreciate in value, paying off your car loan early will help you avoid the risk of negative equity.
What are some of the negatives to paying off your car loan early? These include:
- Prepayment penalties: Some car loans will charge you a fee if you get them paid off ahead of schedule.
- Not being able to pay higher-interest debts: If your auto loan charges you substantially less interest per month than your credit card debt, then it doesn’t make sense to first pay off your car.
- A negative impact on your credit score: In some cases, it makes sense to keep your car loan active in order to have the most positive impact on your credit score.
- Stretching your budget too thin: If accelerating your auto loan payments will make it harder to pay for essentials, then it makes no sense.
For more information about the pros and cons of paying off your car loan early check out the Lantern by SoFi, an online marketplace that educates about a variety of loans.
When to Consider Paying Off a Car Loan
Only after you have considered all of the pros and cons should you decide if it makes sense to pay off your loan early.
If you can easily pay an extra amount each month without negatively impacting other financial goals, then it makes sense to do it, even if you don’t save money on interest payments.
This is because, by freeing up that sum in your budget, you can meet other goals. In many cases, you don’t even have to do this every month to see a benefit.
Or, if you get a tax refund, Christmas bonus, or other additional income, consider a lump sum payment. This will help you reap the rewards with a minimal impact on your fixed budget.
As you can see, while it can make sense to pay off your auto loan ahead of schedule, there are pitfalls as well as benefits to consider. By doing your homework, you will be assured of making the best decision.