For many people, being debt-free is their top financial goal. But even if you have enough cash to pay off your debt quickly – a strategy we often recommend here at Student Loan Hero – that doesn’t mean you always should. If you’re wondering if you should pay off your car loan early, the answer can be more complicated than you think.
Let’s dig into reasons why you should pay off your car loan early – and a few reasons why you shouldn’t.
Pros of paying off a car loan early
Like any debt, a car loan can weigh down on your budget. Getting rid of that debt certainly has its perks.
1. Save money on interest
Let’s say you have a $10,000 car loan with a 14.99% APR and a five-year term. If you pay the minimum amount on your loan each month, you’ll end up paying a whopping $4,271 in interest.
If you add an extra $50 a month to each payment, you’ll pay off the loan more than a year earlier and save $1,072 in interest. The more you pay each month, the more you’ll save. Use a prepayment calculator to find out how much you can save on your loan.
2. Lower your debt load
If you plan to borrow again – such as for a mortgage – the lender will consider your debt-to-income ratio. If your total debt payments are too high relative to your income, they might deny your application. The reason why is simple: The more debt you have, the likelier you are to default.
So if you have the cash to pay off the car loan early, doing so could make it easier to get approved the next time you apply for credit.
3. More monthly cash flow
Once your car loan is paid off, you’ll no longer have to make that monthly payment. This frees up cash for other goals, such as paying off other debt and saving for retirement.
Cons of paying off a car loan early
To some, the benefits of paying off a car loan early make the decision a no-brainer. But if your interest rate is particularly low, take a step back and consider a few things you’re giving up by making bigger payments on your loan.
1. Less cash flow and savings
If you’re adding more money to your car loan every month, that’s less money you have for other financial goals and obligations. For example, if you have debt at a higher interest rate (such as a high-interest credit card), you’d be better off paying that down more quickly.
Also, make sure you’re working toward a fully-funded emergency fund – about three to six months’ worth of expenses. If you put all your extra cash toward debt instead, it can cause more problems down the road if you lose your job, become disabled, or something else unexpected happens. Avoid neglecting other important financial goals when paying down your loan.
To find the right balance with paying off your car loan and saving for emergencies, take a look at your interest rate. If it’s below ten percent, you may be able to afford to put more into your emergency fund. But if it’s above ten percent, paying off the car loan may be more urgent.
2. You could earn more by investing
If your car loan’s interest rate is low, you could get a better net return if you invest your money.
For example, say you have a $10,000 car loan with a 2.99% APR and a five-year term. Your monthly payment would be around $180, and you’d pay $10,779 total. If you were to add an extra $100 a month to your payment, you’d save $292 on interest over the life of the loan.
However, if you invest $100 per month and it grows at an annualized rate of six percent, you will earn $1,012 in interest over five years.
Consider auto refinancing
If your car loan has a high interest rate, refinancing is another way to reduce your financial burden. Depending on how your credit has improved since you originally took out the loan, you could qualify for a significantly better auto loan rate.
Refinancing your car loan at a lower rate would not only reduce how much you pay in interest, it would also lower your monthly payments. You can even refinance with a shorter loan term to further save on interest costs. Banks often charge fees to refinance, though, so make sure the math works out in your favor.
Should I pay off my car loan early?
If you have a high-interest auto loan and no opportunity to refinance, it’s likely worth losing a little cash flow for a while to save on interest. But even if you have a low interest rate, a strong aversion to debt is a good enough reason to pay off your car loan early.
When you have a low interest rate, though, you might be better off investing or saving more each month. This is especially true if you don’t feel strongly about paying off your loan early or need to lower your debt-to-income ratio.
There’s no one-size-fits-all approach to how you should tackle your debt. If you’re wondering whether you should be paying off a car loan early, take a step back and review your finances. Make sure you have savings to manage emergencies and that you don’t have other debts you need to prioritize first.
Interested in refinancing student loans?Here are the top 6 lenders of 2018!
|Lender||Variable APR||Eligible Degrees|
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 5.87% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 5.87% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at email@example.com, or call 888-601-2801 for more information on ourstudent loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
Savings example: average savings calculated based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were disclosed. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
Application detail: 5 minutes indicates typical time it takes to complete application with applicant information readily available. It does not include time taken to provide underwriting decision or funding of the loan.
Instant rates mean a delivery of personalized rates for those individuals who provide sufficient information to return a rate. For instant rates a soft credit pull will be conducted, which will not affect your credit score. To proceed with an application, a hard credit pull will be required, which may affect your credit score.
Total savings calculated by aggregating individual average savings across total borrower population from 9/2013 to 12/2017. Individual average savings calculation based on single loans refinanced from 9/2013 to 12/2017 where borrowers’ previous rates were provided. Assumes same loan terms for previous and refinanced loans, and payments made to maturity with no prepayments. Actual savings for individual loans vary based on loan balance, interest rates, and other factors.
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.47% – 6.99%3||Undergrad & Graduate||Visit SoFi|
|2.47% – 5.87%1||Undergrad & Graduate||Visit Earnest|
|2.47% – 8.03%4||Undergrad & Graduate||Visit Lendkey|
|2.95% – 6.37%2||Undergrad & Graduate||Visit Laurel Road|
|2.48% – 6.25%5||Undergrad & Graduate||Visit CommonBond|
|2.72% – 8.32%6||Undergrad & Graduate||Visit Citizens|