Is There an Advantage to Paying Off a Car Loan Early?

Car loans act much like mortgages, with several primary differences. Car loans tend to have lower interest rates, except for risky borrowers. The interest paid on a car loan does not fall under any tax exemption status, unlike mortgage interest. But because car loans are for such lower amounts than home loans, borrowers can pay them off more quickly and can often make extra payments to retire the loan early. There are several advantages to paying off an auto loan early.

Interest

Interest payments are much easier to handle if a borrower pays off an auto loan early. The interest rate that is applied to the loan applies only to the principal. If the borrower starts paying off more of that principal, the rate will apply to a smaller and smaller amount, leading to lower interest payments in addition to less principal. All early payment will reduce the total amount of interest the borrower is paying--as long as the borrower is paying interest at all.

Credit

Credit scores are affected by how borrowers deal with their debt. Paying a debt off early is a sign that a borrower is financially responsible and pays loans off easily. This may raise credit scores, and even if it doesn't, a lender can look at a credit report as see the account was paid off early. This makes lenders more willing to loan the borrower money for other things like a mortgage and is an ideal process for building credit or recovering from a bad credit decision.

Financial Planning

The sooner a borrower pays off an auto loan, the sooner they will have extra money to spend on other purchases or paying down other debt. This can be useful if borrowers have an eye on another loan or on saving or investing money in a specific way and need extra income to do it. Paying the car loan off early can be part of a long-term financial plan that includes using the extra money for another project.

Methods

Many lenders are willing to work out different ways to pay off car loans early. Some may be willing to accept large lump sums that pay off the rest of the car loan completely, or at least a good part of it. Others may be willing to have borrowers pay off a greater amount of the principal each month, or simply make extra payments each month. Some lenders, however, will charge fees to have the loan paid off early, since they are losing interest on the deal.