Is It a Good Idea to Pay Off My Car Loan Early?

Quick Answer

Paying off your car loan early could make sense if it won’t deplete your savings and you don’t have other high-interest debt that you could benefit from paying off first.

A woman wearing a blue denim jacket smiles while driving her car with the sunset in the background.

If you get a large tax refund or have some extra money socked away in savings, paying off your car loan early might be a consideration. Whether it's the best financial move to make depends on your goals and financial situation.

While paying off a car loan can save you money and eliminate a monthly payment, it could also affect your cash flow, and paying off other high-interest debt first could ultimately save you more in interest. Before paying off your car loan, consider the pros and cons outlined below.

Benefits of Paying Off a Car Loan Early

Here are good reasons to pay off your car loan early:

Lowers Your Debt-to-Income Ratio (DTI)

Paying off a car loan can reduce your DTI because it removes a monthly payment from your budget. Your DTI is one of several factors lenders check to determine if you qualify for a loan—including a mortgage—and lowering it can put you in a better position to qualify. Here's how to calculate DTI:

  1. Total up your monthly debt obligations, such as your installment loan payments and minimum required credit card payments.
  2. Divide the sum of your monthly debt payments by your gross (pretax) monthly income.
  3. Multiply by 100 to convert to a percentage.

You may be able to qualify for a mortgage with a DTI of 43% (or higher in some cases), but 36% or less looks better on your loan application. Personal loans and other types of loan accounts typically have similar DTI requirements.

Saves You Money on Interest

Paying off your car loan can reduce the amount of interest you'll pay over time because you'll no longer be responsible for paying interest once the account is paid off. How much you save, however, depends on the loan's remaining balance. Typically, you pay the most interest at the beginning of a loan, so you may not pocket as much if you pay it off within the last few months of the term.

Gives You Financial Freedom to Pursue Other Goals

Eliminating a monthly car payment from your budget could give you more financial wiggle room to put money toward other areas, such as saving for a special vacation, house down payment or retirement. Once the debt is paid off, part or all of the money that was going to your car loan could even be diverted to your student loans or other debt to pay it off faster.

Drawbacks of Paying Off a Car Loan Early

While paying off debt is usually seen as a good thing, these are some potential drawbacks of paying off your car loan early:

Lenders May Charge a Prepayment Penalty

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 Hurt Your Cash Flow

Taking several thousand dollars from your savings or checking account and putting it toward your debt could leave you with less money to draw from on a rainy day. This could put you in a difficult situation if, say, your car breaks down or you get a surprise bill from a root canal.

When You Should and Shouldn't Pay Off a Car Loan Early

Paying off your car loan early could be worthwhile if you will still have emergency savings socked away after paying off the debt. But you should also consider whether your car loan is your most expensive debt.

The average APR for a new 60-month car loan is 4.55% APR compared with 16.17% APR for credit cards, according to the Federal Reserve. So, revolving a credit card balance from month to month could be costing you more in interest than your car loan, and paying off that account first could help you pocket more savings. Plus, lowering card balances could be good for your credit score if it reduces your credit utilization ratio.

But what if you have a 0% interest car loan? It could make sense to keep making loan payments since eliminating the debt won't result in net savings. Instead of paying off the loan early, you could use spare cash to invest, save for a major purchase or top up your rainy day fund.

How Does Paying Off a Car Loan Affect Your Credit?

Paying off your car loan may have a short-lived negative effect on your score because it would close out your car loan account. While you'll still get credit for on-time payments on that account, active accounts typically weigh more positively toward your score than closed accounts.

If you're thinking about paying off your car loan in hopes of an immediate score boost, keeping the account open and paying on time could actually be better for your score in the near term. This is an especially important consideration to make if you plan to apply for a new credit account in the near future.

How to Save on Interest Without Paying Off Your Car Loan

Paying off your loan in full isn't the only way to reduce the interest you pay over time. If your credit score has increased and market rates have decreased since you borrowed money for a car, you could also consider refinancing your loan. Refinancing to a lower interest rate may lower your monthly payments and the loan's overall cost.

You can use Experian's credit monitoring tool to see where your credit stands before shopping around to compare rates. Just keep in mind that your current lender may also charge a prepayment penalty if you pay your loan off with a new loan from a different lender, so you'll need to make sure the savings from refinancing will be worth paying the applicable fee.

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