You might feel tempted to pay off your car loans before the end of the repayment term so you can lower your debt faster. However, there are several factors you should consider before making the decision. It might be worth it in usual scenarios. However, you should assess your financial conditions thoroughly before deciding to pay off your car loans.
Let us find out the advantages and disadvantages of paying off car loans early.
Advantages
There are several benefits of paying off your car loans early if you have the funds.
Improve Your DTI
Lenders would always check the debt-to-income (DTI) ratio during the loan underwriting process whenever people need loans for cars, houses, or personal reasons. It allows the lenders to understand how much of the applicant’s gross monthly income goes towards repayment of their debts.
When you pay off your car loans early, it improves your DTI ratio because the loan amount gets written off your debt. A lower DTI will make a good impression on future lenders whenever you need a loan or credit card.
Save The Interest Money
With every payment for your car loan, you have to pay the interest accrued on your loan since the last time you made a payment. That means a part of your payment goes towards interest and the rest goes towards the principal balance of your car loan.
However, if you add some money to your regular payments, it will entirely go towards paying the principal, which will bring down your interest. That means, regularly adding to your monthly payments can have a compounding impact on your savings.
For example, if you took a $ 15,000 loan at 4% interest for five years, your monthly payments would be about $ 276.25. That means you are paying an interest of $ 1574.87 as interest during the repayment period. However, if you put in an extra $ 100 with every payment, your interest amount goes down to $ 1121.73, which saves you $ 453.14.
You can use an auto loan early payoff calculator to understand how much interest you can save by adding more money to your payments based on your affordability.
Own Your Car Sooner
Technically speaking, your lender owns your car until the time you pay off your car loan completely. But if you can pay off your car loan, you can take ownership of your vehicle sooner.
That means you can have the title of the car and your name, which gives you more control over what you wish to do with your vehicle. You can sell it off or trade it for another car whenever you want.
Don’t Pay More Than Your Car’s Worth
Almost every vehicle starts depreciating as soon as you bring it home from the dealers. But sometimes, the depreciation could be faster than the payoff schedule, especially if it has a longer repayment term or a high-interest rate.
In such cases, you will end up owing more to the lender than your car’s worth. Paying off such a loan early ensures that you do not suffer such a financial loss over your vehicle, especially when you need to trade or sell it.
Reduce Your Car Insurance
Lenders would need you to purchase collision and comprehensive insurance because they own the car until you pay off the loan and need to protect their investment. However, once you pay off the car loan and own the vehicle entirely, you can choose the coverage you want for your vehicle.
Disadvantages
There are so many benefits to pay off your auto loan early. But there are certain downsides as well that you should keep in mind.
Prepayment Penalties
Sometimes, car loan contracts may have a prepayment penalty clause. It says that if you pay off your loan before the repayment term is over, you will have to pay a fee to the lender. Sometimes, loan contracts can also prevent buyers from paying off their car loans too early.
For example, you may have to pay a prepayment penalty if you want to pay off your loan within six months of purchasing the vehicle. But in such cases, you may not have to pay any fees once the minimum lock-in period is over.
Make sure that you read through your car loan contract thoroughly to check whether such terms apply to you. Even if there is a prepayment penalty, you can compare the fees to the total saving on interests to find the best option.
Your Credit Score Might Dip
We understand that the idea of paying off your debts early hurting your credit score might sound like an oxymoron. However, when you pay off your car loan, you stop making further payments on it.
It can affect your credit mix since the credit bureaus usually look for payment installments on loans, as well as credit cards. However, the dip in your credit score is often temporary and bounces back as long as you maintain your credit accounts.
There can be several other factors to consider when you decide to pay off your car loans early. For example, you may need the money for other reasons immediately after you pay off the loan, or it might disrupt your overall budget.
So make sure that you calculate these factors carefully before jumping to the decision of paying off your car loan. However, there are several advantages that you can enjoy as long as you can afford the payment.
