Should You Pay Off Your Car Loan Early?

7 Min Read | Published: May 8, 2024

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Paying off your car loan early could be a smart financial move, but you’ll want to carefully consider the pros and cons to see if it’s best for you.

At-A-Glance

Paying off your car loan early could be a smart financial move as it could help you to save on interest.
However, paying off your car loan early could mean that you’ll incur additional fees. Additionally, it could impact your credit score, although the impact is typically minimal.
In some cases, it could make sense to pay off other high-interest debts first.

Paying off your car loan early could be a smart financial move. It could help you to save on interest and free up more cash for you to use each month. Likewise, paying off your car means that you’ll own it outright, which is an exciting prospect for many people.

However, there are a few downsides to paying off your car loan early: including fees and a potential dip in your credit score.

In this article, we’ll look at the pros and cons of paying off your car loan early. See whether it makes financial sense for your situation.

Benefits of Paying Your Car Loan Off Early

You Could Save On Interest
Paying off your car loan interest early could result in you paying less interest over time. That’s because a portion of your payment each month goes toward paying the amount that you borrowed, while part goes to paying interest on the loan. Keep in mind that the type of interest that your loan uses will impact how much money you’ll save by paying it off early.
- Simple Interest
  If your loan uses simple interest, the amount of interest that you pay is based on the amount that you still owe. Paying off your loan early, in this case, can reduce the amount of interest that you end up paying over time as it shortens the duration of your loan.
- Precomputed Interest
  Some auto loans use precomputed interest. With precomputed interest, interest is calculated upfront and added to your principal at the beginning of your loan. With this type of loan, you may still have to pay the precomputed interest even if you pay it off early.¹
When considering paying off your auto loan, you’ll also want to consider what other outstanding debts you have. If you have other debt with a higher interest rate than your car loan, then it could make sense to opt to pay off this debt first for greater savings over time.
You’ll Avoid the Risk of Owing More Than Your Car Is Worth
Another potential benefit of paying off your auto loan early could be that you reduce the risk of ending up with a loan that is greater than the value of your car. This could happen if you have a long-term loan and your car’s value depreciates in that time. Should you end up totaling your car or selling it, you may have to pay the difference between the loan’s remaining balance and your car’s value.
You Will Own Your Car Outright
As long as you’re still making payments on the loan, the lender will typically still own the car. Paying off your car loan early means that you’ll own the car free and clear.

Downsides to Paying Off a Car Loan Early

Here are a few potential drawbacks to paying off a car loan early:

Prepayment Penalties
In some cases, borrowers are charged a fee for paying off a loan early because the lender will lose out on interest they would have earned from the loan. You can check if your contract has a prepayment penalty fee by reviewing your loan agreement.
It Could Cause a Financial Shortfall
Paying off your car loan could cause a financial shortfall if you’re using a significant portion of your savings to do it. This approach could leave you with less money in case of emergencies.
It Could Cause Your Credit Score to Dip Slightly
Paying off your car loan may lower your credit score slightly in the short term.² This is because it reduces your average account age and credit mix. Therefore, you may postpone your payoff if you need to maximize your credit score for a big purchase or open a new credit account.

However, this drop is usually only temporary.³ Lenders prefer to see borrowers paying off installment loans, as it demonstrates good debt management skills more so than simply avoiding all debt.

As long as you continue using credit responsibly and making on-time payments, your credit score could recover and keep increasing.

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Situations Where It Might Make Sense to Pay off Your Car Loan Early

Here are a few reasons why it might make sense to pay your loan off early:

If the Loan Has a High Interest Rate
Paying off a loan with a high interest could reduce your interest costs substantially. This could lead to greater financial security from month to month. Just make sure the loan doesn’t use precomputed interest, because this could mean that there may be less incentive to pay it off early.
If You’re Not Worried About a Slight Dip In Your Credit Score
A slight, temporary dip in your credit score is not often something to worry about if you don’t need to get a new loan or credit card soon. Therefore, there may be little to no downside to paying off your loan early if you won’t need new credit for a while.
If You Need to Lower Your Debt-to-Income (DTI) Ratio
Your DTI ratio measures your monthly debt payments against your monthly income. Mortgage lenders consider your DTI ratio when approving you for a mortgage. A lower DTI ratio is more favorable. Therefore, paying off the auto loan could help you if you need to reduce your DTI in order to obtain a mortgage. One strategy would be to pay your car loan off early if you’re planning to get a mortgage. That way, your credit score will have a chance to recover, and you can still benefit from having a lower DTI ratio.
If It’ll Free Up Capital Which You Can Then Invest Wisely
Paying off a loan provides additional monthly cash flow and reduces interest costs. You could use these extra funds to invest wisely, potentially moving toward financial goals faster. Keep in mind, however, that this scenario only makes sense if your projected returns will potentially outweigh the interest savings that you’d have from paying off the car loan.
If There Are No Prepayment Penalties
Some lenders charge prepayment penalties to make up for interest they could lose if you pay the loan off early. This could potentially outweigh any potential interest savings, especially if you’re nearing the end of your loan’s term and there’s not much interest left to pay. Be sure to carefully review your loan documents to see whether there are any prepayment penalties.

Frequently Asked Questions

You may be able to pay off a car loan early by making extra payments on the loan. However, check your financing documents first to see whether there’s a penalty for paying off the loan early.

This depends on your situation. It could make sense if you will not need new credit soon and there are no prepayment penalties. You’ll also want to consider what type of interest is being charged on the loan, and whether there’s another outstanding debt that has a higher interest rate that you may want to consider paying off first.

Your credit score may dip slightly when you pay off a loan. This could be due to a number of factors including the fact that it may reduce your average account age and credit mix. However, this is typically only temporary. Continued responsible credit use could help your score to bounce back.

The Takeaway

If you’re thinking of paying off your car loan early, you’ll want to consider the pros and cons carefully to see whether it’s the best choice for you. Sometimes, paying off the loan could help you to save on interest, but other times it might make more sense to forgo paying off the car loan early.

¹ “Does Paying Off a Car Loan Early Hurt Your Credit?,” Experian

^2,3 “Does Paying Off A Car Loan Early Hurt Your Credit?,” Forbes

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Bradley Schnitzer is a writer and email strategist who has covered personal finance and small business topics for over five years. He is passionate about personal finance and helping others understand their money.

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.

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