When your car loan is coming to an end, many people opt to pay it off early—but what are the benefits of doing this, and are there any disadvantages?

Paying Your Car Loan Off Early

A big amount of debt is an issue that is affecting many American families and it's leaving a big empty hole in their wallets. If you have a car that you're paying off each month, you could benefit greatly from paying that loan off early. How? Well not only will it save you some extra money each month, but paying your loan off can help your credit scores, too. Unfortunately, this option is not available to some people, and there are things you should definitely check into with your lender before you go ahead and write a sizable check to your lien holder.

Benefits of Repaying Your Car Loan Early

Your monthly cash flow will get a bit bigger if you are able to pay your loan off early because it will cut down on the amount of interest you pay. With the money you save on your interest rate you could make home improvements easier, pay off your credit card debt, or possibly save it up for your child(ren)'s college fund. The possibilities are endless with your new savings!

When you take out a new loan – of any kind – your score will immediately drop a few points because you have now used up some of your available credit; but the sooner you pay it back, the sooner you can regain those points. A few points shouldn't make a huge difference if your credit score already falls in the "prime" or "super-prime" category on the FICO scoring system, but if you happen to fall in the "subprime" category it could mean the difference between an auto loan approval or a denial with a traditional lender. So, what happens if you can't do this?

When You Can't Pay Off your Auto Loan Early

Even if you have the extra money saved up to pay your loan off early, you may not be able to. In some cases, it won’t make a difference even if you do. Say what? Yes, this is true because there are some auto financing companies that will hit you with a "Rule of 78' loan.

This method pre-calculates how much interest you will pay over the life of your loan and loads the majority of that interest into the first half of your loan. Even if you to decide to pay the loan off early, the payoff amount would include the remaining interest payments. If you pay it off early enough, you might be entitled to an interest rebate, but this amount would still be less than the remaining interest you'd already paid.

However, most auto loans now feature simple interest contracts, which are calculated based on the amount you owe (Congress passed a law in 1991 that made it illegal to apply the Rule of 78 to any loan longer than 61 months). With a simple interest loan, the interest you pay on the loan is calculated day-by-day based on the principal balance. Basically, the quicker you pay the loan off, the less interest you end up paying over the loan term. Simple interest loans rarely, if ever, come with early payment penalties. In fact, a pre-payment penalty is something you should ask about before signing any loan-related paperwork.

If you do have that rare simple interest loan with an early payment penalty, you'll need to do some number crunching before deciding to pay it off early. In particular, you need to find out if the penalty will result in you paying more out of pocket than just sticking to the payment schedule. If it does, it wouldn't be worth paying the loan off early.

Paying Your Car Off Early In a Few Simple Steps

So, you've read through the pros and cons, looked over all of your loan paperwork, and have determined that it would be beneficial to you to pay the loan off early. Now, all you need to know are the steps on how to do it. There are actually a few different tactics you can choose to take and they include:

  • Round up on your monthly payment amount
  • Make bi-weekly payments
  • Send in just one extra payment per year
  • Never skip a payment

Rounding up your payment is probably the easiest and cheapest way to get out of your loan early. You don't have to add a lot each month, but remember that the more you add to the payment amount the quicker the loan will get paid off. For example; if your car payment is $385 per month you could send in a check for $400 each month and pay your loan off almost six months early.

Making bi-weekly payments on your car loan may seem like an extra hassle to add into your life but if you can remember to do it each month, it could be a life saver. We aren't even talking about making the $380 car payment twice a month, although that would help too, we are talking about splitting that number in half. In other words, you would pay $190 twice a month and you would be paying less interest. This could help you repay your loan about 4-5 months earlier than planned.

Not everyone has the cash flow or pay schedule to make bi-weekly payments and that's okay. You can still achieve the same goal by making just one extra car payment a year. You can use your tax refund, birthday, Christmas, or any other source of extra cash to do this. Many times any extra money over the minimum required payment will be applied to your principal balance, which means that with one extra payment your principal loan balance will lower by $380.

Never skipping a payment seems like a no brainer to anyone, but you'd be surprised by how many people take advantage of these payment programs offered by dealerships and lenders. These are often encouraged around the Holidays, but it's a ploy to tack on extra interest and payments to your loan. Think of it this way; if you skip your payment once, you need to add on one month to your loan term and possible additional interest charges. Each time you do this you have to add on another month and more interest charges, and in the end you're not saving any money at all.

As We See It

If you have a simple interest auto loan, then it most likely does not carry any penalty for paying it off early. If you have the means to do so, you could save yourself a lot of money on interest charges in the long run and lessen your debt load quicker. If you want to save money another way, but don't have the money to make any extra payments you can apply for a loan refinance.

At Auto Credit Express, we specialize in helping car shoppers find affordable auto financing on a car that they really need, regardless of their credit – but that's not all. The dealerships in our network also can help you qualify for low auto financing rates. Get started today by filling out our online application, and you could be experiencing savings within days.