Paying Off a Car Loan Early: Advantages and Disadvantages to Consider

By Upstart Content Team | Updated March 29, 2022
reading time 6 min read
Man leaning on black car using his cell phone to learn about how to pay off a car loan early.

You might be asking yourself whether you should try and pay off your car loan sooner. Speeding up your repayment timeline definitely has benefits, but doing so has potential drawbacks too. 

For most people, paying off a car loan early can be worth it. But before you make any concrete decisions, you need to assess your financial situation and learn about the possible pros and cons before making the jump.

Can you pay off a car loan early?

Yes, but while speeding up the repayment timeline for your car loan may help you get off of the hamster wheel of debt faster, it doesn’t mean that you should.

When does it make the most sense to pay off a car loan early?

Paying off a car loan early is a big financial decision and, given the potential drawbacks, it doesn’t always make sense for someone to put their time and energy into it. However, there are some scenarios where it might make sense to get rid of your auto debt sooner rather than later:

  • You don’t have any (or very little) outstanding debt. If you don’t have any high-interest debt and you’d like to have more money to use for another financial goal, paying off your car loan sooner might help.
  • You have the money to spare. If you recently got a financial windfall, but you already have a solid savings and emergency fund, you can use the extra influx of cash to pay off your auto debt.
  • You’re trying to save for a future purchase. If you’re thinking about making a big purchase, like getting a home, and you’re just starting to save for it, you need to lower your debt-to-income (DTI) ratio and boost your spare cash (which we’ll talk more about shortly!). Paying off your car loan early can help you do both.

Advantages of paying off a car loan early

Paying off your car loan early could be a solid financial move for you. Let’s check out a few reasons why. 

Save money on interest

The biggest reason you may want to pay off your car loan early is to save money on interest. As a quick refresh, the interest is the cost your lender charges you for borrowing money from them. It’s a percentage of what’s left of the principal loan balance. Each month, you pay back a portion of your total loan amount with a bit of interest added in. 

If you pay more than the minimum each month, all the extra money reduces the principal loan amount, not the interest. The next payment will have less interest charged because the principal loan amount will be lower. The sooner you pay off the loan, the more money you’ll save in interest payments.

Free up money for other expenses

If you pay off your car loan early, you can use some or all of the money you had intended to use for the remaining loan payments for other financial needs. You can use the extra money to pay down other debts, build up an emergency fund, or beef up your savings.

Avoid being upside-down

It’s common for cars to lose their value over time and sometimes the value of the car drops faster than you can complete the car loan repayment term. It’s called being “upside down” on your car loan and can happen if you have a long loan repayment term or a high interest rate. It means that you have no equity in your car and you owe the lender more than your car is worth. 

Being upside down on your car loan could become a problem if you try to sell the car, or if the car is totaled. For example, if your car is totaled and you still owe more on your loan than the car is worth, you’re responsible for paying back the lender the full outstanding loan balance rather than the actual cash value of your car before it was totaled. By paying off your car loan early, you avoid this risk.

Lower your DTI ratio

Your DTI ratio is the amount of debt you need to pay for compared to the amount of money you make. As we mentioned earlier, paying off your car loan early can help you lower your DTI ratio, since you’ll be getting rid of a significant amount of debt. By lowering this ratio, you might be able to improve your credit, get approved for other loans, and qualify for lower interest rates.

Disadvantages of paying off a car loan early

While you may want to say “yes” to paying off your car loan early, you need to consider some potential disadvantages before you decide.

Prepayment penalties

Some lenders charge a prepayment penalty, which is a fee your lender may charge if you pay off your car loan early. That fee, if the lender charges it, will be listed in the terms of your car loan agreement. Think carefully about whether the benefits of paying off your car loan early will outweigh the cost of this fee. If the cost of this fee is more than the interest you have to pay over the remaining loan term, it might be best to continue making your monthly payments instead of paying off your car loan early.

Budget strains

As much as you might want to pay off your car loan early to get it out of the way, it’s essential that you don’t risk your budget. When you consider paying off your car loan early, you need to think about your other monthly expenses and income to make sure you can afford to pay it off without risking your financial situation. Even though paying off your car loan in advance might help you save money on interest, it could also make it harder for you to pay for your other monthly payments, or to pay for surprise expenses that show up unexpectedly.

Negative impact on your credit score

Paying off your car loan early might have a negative impact on your credit score. This may sound silly, since paying off a loan early seems to be a responsible credit choice to make. In fact, any time you pay off a debt early or by the end of the original loan term, it typically causes your credit score to drop. Your credit score will likely decrease when you pay off a loan, because the consistent monthly payments you were making will end. 

Another factor that can cause your credit score to dip is that by closing out a loan, your credit mix will change. This matters because credit bureaus prefer that borrowers have a combination of both installment loans and credit lines. Even though it might be alarming to see your credit score drop, the dip you might see if you pay off your car loan early is typically small and temporary. As long as you continue to manage your credit accounts responsibly, your score will probably rebound within a few months.

How to pay off a car loan early

When it comes to paying off your car loan early, you have several options: pay it all at once, pay off a chunk of it, or pay more than the minimum. The right choice for you depends on what works best for your financial needs.

Make a single lump-sum payment

The first option, and perhaps the most ambitious, is to pay off your remaining car loan balance all at once with a single lump-sum payment, which can be hundreds or thousands of dollars. If you select this option, contact your lender to know what your remaining car loan balance is and what fees you may need to pay. That way, you’ll know how much money you’ll need.

Pay off a chunk of your balance

If you contact your lender and the total balance you owe on your car loan is more than you can afford to pay in full, then consider making a partial lump-sum payment instead. Even though this method will not decrease your monthly payment, it’ll help to significantly reduce your loan term.

Pay more than the minimum

If you don’t have a lot of extra cash to put toward your car loan balance, you can still make progress by paying more than the minimum each month. You can pay a little extra when you have it or you can commit to an extra payment every two weeks. Every little bit helps!

Decision time: Should I pay off my car loan early?

It depends. We know that’s probably not the answer you’re looking for, but it really does depend on you and your financial situation. If you take a long hard look at the pros and cons and you decide that it might not be the right move for you, that’s okay—you still have options!

Instead of giving your loan debt the boot, you can refinance your car or adjust your budget so that you can still pay off your car loan early, just not right now. 

No matter what decision you make, remember to choose a financial path that fits your unique needs and financial situation.

Car refinance loans not available in IA, MD, NV, or WV.

This content is general in nature and is provided for informational purposes only. Upstart is not a financial advisor and does not offer financial planning services. This content may contain references to products and services offered through Upstart’s credit marketplace.

About the Author

Upstart Content Team

The Upstart Content Team shares industry insights, practical tips, and borrower success stories to help people better understand the important “money moments” of their lives.

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