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Why it can be a smart idea to pay off car loan early

Isaac Diaz, who turned 40 in June, has kicked his plan to pay off his car loan into overdrive. 

“Right now, I’m focused on paying my car off,” Diaz says. “I’m so happy because I’m only a few months removed from paying this thing off.”

Diaz owns a 2013 Acura TSX that he refinanced in 2019 for $15,249 after buying it used a few years prior. At the end of April, he had about $4,999 remaining on his loan. But over the last few months, Diaz has managed to shave off almost $2,000, bringing his loan balance to just $2,999 as of June 24.

Typically, his car payment is $371 a month, but recently, Diaz has been paying about $630 extra every month to bring it to an even $1,000 and help him get rid of the debt quicker.

“I am paying a lot more extra on that car loan, but it’s gonna pay off because that car is gonna be mine,” Diaz says. After his car is paid off, Diaz plans to start rolling the money that he was putting toward it into his student debt. He has about $6,000 left on his student loans. 

“Paying extra is so hard right now because there are other things that I could be doing with that money, but it wouldn’t be setting me up for success later,” Diaz says.

Why paying down a car loan can be a good approach

Experts say that paying off a car loan early can be a smart approach if you’re able to afford it. “It’s always a good idea to pay down your loans and a car purchase is probably one of the biggest loans that people take out short of a home purchase, so it’s a good place to start,” says Ronald Montoya, senior consumer advice editor with auto research company Edmunds.

Beyond peace of mind, there are tangible benefits to paying off your car loan, Montoya says. For one, it could save you money on interest, especially if you have a 60-, 72- or even 84-month auto loan. 

Say you took out a $30,000 loan with a 6-year repayment term and a 5% interest rate. You’d end up paying nearly $35,000 in total ($30,000 for the original principal and just under $5,000 in interest). But if you pay off that loan early, you could cut back on some of that interest.

Paying off your car loan can also take pressure off your monthly budget, Montoya says. After your car is paid off, you now have extra money you can use to pay down other debt, increase savings or put toward expenses. 

But before starting to pay off a loan early, consumers should check to see if their lender even allows it, Montoya says. “Make sure that you look into what fees they would charge if you pay down your loan early,” he says, since some lenders charge a prepayment penalty.

Another pitfall to avoid, Montoya says, is the “temptation of wanting to jump into another car purchase.” A lot of people treat paying off their loan as a reset and a time to buy another car, he says. But by doing that, you’re losing the opportunity to own a car without having a car payment. 

If paying off your car loan is not the right move, it may be worth looking into refinancing. “If you have a high interest rate and your credit has remained solid or it’s improved since you’ve taken out that initial loan, it’s definitely worth considering refinancing,” Montoya says. 

Currently, interest rates are “pretty low right now,” he adds. The average interest rate for a new car is currently about 4.5%, with an average term of around 70 months, according to Edmunds. Interest rates for used cars are slightly higher, 7.7%, for an average loan period of 69 months.  

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2021-07-08 13:30:17

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