Advertisement

Can I pay off my car loan early?

red and black car under dollars
Yes, borrowers can pay off their car loans early, but it might hurt them.

While paying off a car loan gets borrowers out of debt, it can damage their credit score making it more difficult to get another type of loan, such as a mortgage. It’s quite ironic considering that most financial advice says to pay off your debt as fast as possible, but haste can make waste as far as credit scores are concerned.

Self-Injured By Early Payment

Colin Grussing, Founder of BeGreenMan.com, told loans.org that when he graduated college in 2008, he started a successful spandex business. Using his newfound wealth, Grussing paid off his $12,000 car loan for his truck. Years later, he sought to develop businesses in real estate.

“However, when I went to the bank to try to get my first commercial loan to buy an 8-plex, I was told by the loan officer that, despite my sound financials and my timely payment of bills, I had damaged my budding credit when I paid off my car loan,” said Grussing.

Since this budding entrepreneur didn’t own a house, nor had he made any other large purchases, his credit score didn’t have the fuel necessary to grow.

“My only big purchase was my car, but because I paid it off relatively soon after I acquired it, I didn't get the benefit of building credit that I could use in my new ventures.”

Car shoppers who want to borrow money for a car are advised by Grussing to not pay off their car loan so that their credit history can be built up.

He explained that there are tradeoffs to paying a car loan off early, and deciding whether or not to pay it off is completely dependent on a borrower’s personal situation. He suggested that car loan borrowers look at their priorities and decide what their best course of action should be.

“If minimizing how much you pay in interest is your number one priority, then you should pay it off,” said Grussing. “However, if raising your credit score is more important, then you should continue paying the note.”

Three Ways to Get Hurt

Krishna Kaliannan, Founder of AutoSwan, told loans.org that paying off a car loan can actually hurt borrowers in one of three ways:

  • prepayment penalties
  • depletion of savings
  • lost opportunity costs
Prepayment penalties can often be so costly that they sometimes outweigh the cost of savings from paying off car loans early. Then, by using personal savings to pay off a car loan, borrowers can wind up without any money to handle emergencies. Finally, by paying off an auto loan early, borrowers can lose the chance to do something better and more profitable with their money than simply avoiding a few additional interest payments.

Still though, Kaliannan pointed out that borrowers can sometimes benefit by paying off their auto debt early.

He said that borrowers will save money on interest payments and by no longer having to make monthly payments. Then there are also some less expected saving options that become available to those who are not burdened by auto loans.

“Many lenders require you to carry a more comprehensive insurance package than base insurance packages and thus, if you pay off the loan, you could downgrade your insurance and save money,” he said.

Difficult Debt Decisions

Most borrowers save money with the goal of spending their savings on a large purchase, namely a down payment on a home for many would-be-homeowners. For those already riddled with debt, and for those thinking about taking on more, the decision to pay an auto loan off early varies from situation to situation.

When it comes down to deciding whether to pay off a car loan or to make a down payment on a house, Kaliannan says that it generally depends on each person’s financial situation.

“Home mortgage interest payments are tax deductible, and thus, it can be wise to purchase a house, if you can afford one,” he said. “Additionally, if you own a home, you can pay off your auto loan by taking out a home equity loan (HELOC) to pay the auto loan.”

Kaliannan also said that while interest payments toward home equity loans are tax deductible, car loan payments are not. As a result, by prioritizing car loan payments over HELOC payments, borrowers miss out by saving money on a tax deductible. Of course, Kaliannan cautioned that if borrowers have a home equity loan with a variable interest rate, then they could end up owing a large amount of money.

As far as student loan debt goes, Kaliannan advises borrowers to look at the interest rate on both their student debt and their car loans in order to determine which one to focus on first. Ideally, the loan with the higher interest should be paid off first. However, this can be a more complex decision than one might immediately assume since student loan interest is tax deductible.

Regardless of what one decides to do, Kaliannan recommends that consumers keep at least two months’ worth of savings and not to deplete that stockpile in order to pay off a car loan.