Should You Pay Off Your Auto Loan Early? The Pros and Cons
Paying off a loan early might seem like a smart move. Why stick with a loan when you can either refinance with better terms or pay it off completely?
There can sometimes be consequences to early repayment, and those consequences aren’t always obvious. Depending on your loan terms, financial goals, and other obligations, early payoff could save you money, trigger prepayment penalties, or reduce your financial flexibility.
There are also scenarios where the savings from auto loan refinancing might justify the cost of prepayment penalties.
The math can get complex, which is why it’s often beneficial to perform your own calculations or work with an experienced auto loan expert before making a decision.
What Paying Off Early Really Means
Paying off your auto loan early means making extra payments toward the principal or paying off the entire balance before your loan term ends. It might sound like a guaranteed way to save on interest, but the benefits depend on how your loan is structured.
Some loans use simple interest, where interest accrues daily. In these cases, early payoff can help reduce the total amount you pay.
Others use precomputed interest, where much of the interest is built into the loan upfront. With those loans, you might not save much, or anything, by paying early. In fact, some loans include prepayment penalties, which could reduce or erase any financial benefit of early repayment.
One of the most common scenarios in which people repay loans early is auto loan refinancing. This involves taking out a new loan, often with a better rate or different terms, to pay off the original one. It resets your loan and may lower your monthly payments or shorten your loan term.
Because refinancing counts as an early payoff, be sure to check for any penalties or loan terms that could reduce or eliminate your savings.
Do All Auto Loans Allow Early Payoff?
Not all auto loans are the same when it comes to early repayment. Loans from credit unions like Ouachita Valley FCU typically allow early payoff with no penalty and use simple interest, which makes early payment more worthwhile.
Other types of loans, such as those from certain third-party lenders, may include prepayment penalties or use precomputed interest. If you're considering early payoff or refinancing, it’s important to review your loan agreement or speak with your lender so you understand the potential cost or savings.
When Early Payoff Makes Sense
You’ve received a raise or new job and can comfortably absorb the larger payment.
You want to free up your monthly budget by eliminating your auto loan payments.
You plan to apply for a mortgage or another large loan soon and want to improve your debt-to-income ratio.
You simply want to own your car outright for peace of mind or insurance flexibility.
In these cases, early payoff can help you reduce your overall interest and gain more control over your finances.
When It Might Not Be the Best Move
You have a low interest rate and affordable monthly payments.
Paying off the loan would drain your emergency fund or savings.
You carry higher-interest debt, such as credit cards, that should take priority.
You're nearing the end of your loan term and wouldn’t save much in interest anyway.
In these situations, keeping the loan and allocating your money elsewhere could offer a better return or more security. You should calculate your break-even point before making extra payments or refinancing to make sure it actually saves you money.
Auto Loan Debt Versus Other Financial Goals
Debt isn’t inherently bad, especially if it’s low-interest and helps you build credit. A well-managed auto loan can show positive payment history and improve your credit profile over time.
You may find it’s better for your credit to pay off high-interest credit card balances and keep your auto loan as is. Alternatively, putting extra cash into your emergency fund or retirement savings could strengthen your overall financial health more than accelerating your car loan payments.
Need Help Reviewing Your Current Loan or Exploring Refinancing Options?
Paying off your auto loan early can be a great move, but only if the math works in your favor. It often makes sense to review your loan terms, consider your other debts and goals, and discuss your situation with an auto loan professional you trust before deciding on the ideal way forward.
Ouachita Valley FCU is here to help members compare their choices and make informed auto loan decisions. Call us at 318.387.4592 to learn about our auto loan services for Monroe and Ouachita Parish households.
