How to Pay Off a Car Loan Early

How to Pay Off a Car Loan Early
••• Photobuay/iStock/GettyImages

Signing up for an auto loan may make it easier to fit a new or used vehicle into your budget. However, dealing with the monthly payment obligation and the interest accrued might encourage you to pay off this debt early, especially if you have certain financial plans.

Depending on your lender's terms, a few options exist to work toward paying off your car loan faster over time or even paying it off all at once. But before you decide, take a look at the pros and cons of paying off your auto loan early along with how to make extra payments and what to expect after you've finally got a zero balance on the account.

Understanding Auto Loans and Payoff

Agreeing to auto financing means more than just signing up for a ​24- to 84-month​ commitment to make regular monthly payments toward the cost of the vehicle.

First, a portion of each month's payment consists of simple interest charged on the loan's principal. While this can be just a few percent for those with excellent credit, some borrowers with bad credit can get double-digit interest rates that ultimately make the car much more expensive. Second, the auto loan makes the lender a lienholder, so you risk the lender taking your vehicle if you don't hold up your end of the loan agreement by skipping payments.

Due to how car loans work, there's a good chance you'll end up paying interest for years that could significantly add to the cost of the car and encourage you to look into an early payoff. The car loan also appears as a current debt account on your credit report and is factored into decisions for other credit products like mortgages and credit cards. Lastly, the secured nature of this type of loan can lead to issues when selling the car, since your title will still show the lender as the lienholder, and the balance needs to be paid off to get them removed.

Benefits of an Early Payoff

If you pay your car loan off early, you could experience some of these benefits:

  • Lower debt load​: Having the car loan on your credit report can make it harder for you to qualify for more credit, especially if you have a high level of other debt, too. The loan impacts your credit utilization and can lower your credit score so that financing becomes more expensive or harder to obtain. Since lenders often look at your credit score alongside your debt-to-income ratio, paying off the car early could give you benefits from the lower debt load. That can really come in handy if you plan to apply for or refinance a mortgage or you want to make another major purchase soon.
  • Less interest​: The longer you keep your car loan active, the longer you pay interest, which means you ultimately spend a significant amount more than your car's actual price. Car loans do come with the benefit of simple interest rather than the more expensive compounding version, but it can still add up. Whether you pay off the whole car loan at once or make extra payments toward the principal, you can reduce the interest and lower the total financing cost of your car.
  • Less hassle​: Like with other monthly payments, car loans come with the hassle of keeping up with payments to avoid fees or other repercussions, like having the vehicle taken away and seeing your credit score drop significantly. Paying off the car loan early eliminates one of your obligations so you can avoid complications and manage your finances more easily.
  • Release of lien​: Having a lien on your car title because it's being financed can create hassles if you decide you want to sell the car and get a new one. You need to pay off the auto loan to get a lien release letter that allows you to visit the local agency for motor vehicles and have the title changed to remove the lender. So, paying the loan off beforehand gives you more flexibility.
  • Cheaper car insurance options​: When your car has a loan on it, the lender usually requires full coverage auto insurance that comes with a higher price tag. Paying off the loan releases you from the lender's minimum insurance requirement and gives you access to more affordable car insurance options such as those with minimum coverage.

Downsides of an Early Payoff

Depending on your loan's terms and your financial situation, paying off a car loan early can come with these downsides:

  • Loss of cash reserves​: Although having your auto loan paid off can offer some financial relief, since it allows you to keep some extra cash from your pay, keep in mind it can also mean giving up thousands of dollars you've saved over the years. This can put you at risk if you don't have much savings left over. If you're short on cash when you encounter an emergency, you might need to get credit again and possibly pay a higher interest rate than your car loan had.
  • Potential lack of interest savings​: While it's true many car loans come with interest, that's not always the case, since you might have qualified for a 0 percent financing deal. If that's the case, paying off your car loan early won't necessarily save you money since you're not paying interest anyway. In this case, you'd mostly benefit from the reduction in overall debt and having one less payment to make.
  • Impact on credit score​: Even though paying your car loan off lowers the amount of debt considered in your debt-to-income ratio for future credit, this action could have a negative impact on your credit score due to how it changes your credit standing. After all, having the loan closed lowers your total available credit, makes your credit mix possibly less diverse and impacts the average age of accounts. Luckily, the impact is usually minor as long as you keep your other accounts open and in good standing. But you might want to rethink the decision to pay off the car if a drop in your credit score could impact an upcoming credit decision.
  • Opportunity cost​: The money you use to pay off your car loan could have other uses, such as investing the cash where you could get a better return than your loan's interest rate. This especially applies when you have a special financing offer with extremely low interest or none at all. So, by paying your loan off with your money rather than continuing the normal payments, you may miss out on some profitable opportunities.
  • Prepayment penalties​: Your auto loan contract may mention you're subject to prepayment penalties that can apply whether you're paying off the loan yourself or refinancing. These can eat into potential interest savings unless your lender waives them for you.

Getting Loan Payoff Information

If you've weighed the pros and cons of early payoff and decided it's right for you, take a look at your auto loan terms as the next step. Look for a section that discusses any penalties for paying off the car loan early, since many states allow this, especially if your loan has ​less than a 60-month term​.

Depending on the lender, you might have to pay this fee even for a partial payoff, and it's worth contacting them to try to work out a prepayment penalty waiver. If you're not too far off from your final payment anyway, you might find it's less of a hassle to just continue making normal payments.

You should also contact the lender before you proceed with any type of early payoff. Even if you just want to send in extra money to go toward the car loan's principal, LendingTree warns your lender may not let you do this and might just let you make your usual future car payments early. Your lender can discuss how much of a lump sum you'd need to pay to finish the loan early. While you might assume the current balance you see in your online banking is the amount due, that amount doesn't consider the interest that's charged daily until the final payoff happens.

When you're seeking to pay off the full loan early, your lender should give you a 10-day payoff quote when you contact them by phone, online or in person, but you might have to wait for a letter to come in some cases. This amount includes the principal and interest calculations, and you have ​up to 10 days​ to make the lump-sum payment. If that deadline expires and you haven't paid, that doesn't have any negative impact on your account, but you need to go through the process of getting another quote before you can go pay off the account.

Paying Off Your Auto Loan

If you've decided to just put more money toward the principal every month, it helps to try an online calculator to see how this decision would impact the total interest paid on your auto loan. For example, if you were ​36 payments​ in on a ​60-month​ auto loan with a ​3.5 percent​ interest rate and ​$25,000​ original balance, paying an extra ​$100​ a month toward your principal would shave ​four months​ off your loan term and save ​$70​ in interest. You could strengthen this effect even further by making double car payments each month.

To make your extra loan payments, you can often use the usual route you prefer like paying online, sending in a check or taking money to a local branch. However, check with the lender since they might require you to somehow note you want the extra money to go toward the principal. If your lender doesn't allow principal-only payments, you can still accelerate paying off your loan by sending in an extra full car payment whenever you can. Your auto loan statement should display how many payments remain so you can plan your strategy.

If you've obtained a ​10-day payoff amount​, the process for fully paying off the loan doesn't differ except that you probably have to write a large check or do a significant money transfer. Also, check that you have a zero balance after the payoff has processed through the bank's system.

Understanding What Happens After Payoff

Finally seeing that zero balance on your car loan brings you both a feeling of accomplishment and more freedom. Besides knowing you don't have to make any more payments, you no longer have to worry about the lender repossessing your vehicle. You should check with your state to find out your next steps for getting the car title only in your name. You might receive a letter from the lender to take with you to file the title transfer paperwork. Since your lender needs to communicate with your state about the loan payoff, it can take ​up to six weeks​ before you have the new title in hand.

Once any title issues are handled, you're free to sell your car in the future since you're the full owner. You can contact your car insurance company to inform them about the loan payoff, since they keep information about the lienholder on your record. At that time, you might also decide to research more affordable car insurance options, but you still need to follow state requirements and weigh the pros and cons of downgrading your coverage.

Read More​: What Is Car Repossession?