It is a general best practice to pay off your car loan before the term is up—as long as there are no prepayment penalties associated with doing so. Another item to account for is whether you have other high-interest debt or urgent expenses to worry about first. When deciding, you should weigh the rate on your auto loan, budget, and overall financial picture. Let's examine the pros and cons of getting out from under your auto loan early.

Advantages

On the totem pole of importance, building an emergency fund and paying off high-interest debt rank above paying your car loan off early. However, if you’ve already secured a substantial emergency fund to cover unexpected expenses or want to rid yourself of the extra debt hanging over your head—then by all means, pay your auto loan off early and give your financial wellbeing a boost.

Here are some advantages to paying off your car before the term ends:

1. Save on interest. Paying off your auto loan early means you’ll save money on loan interest that the lender was charging you. Shaving even just one year off your auto loan’s term could save you a substantial amount of money. For example, let’s say you took out a $20,000 loan with  an interest rate of 5% over a 60-month term. Paying it off in 48 months would generate a savings of about $500 in interest, according to Credit Karma.¹

2. Own the car. When you pay for the vehicle in full and the lender releases the title, you own the car, not the lender. So, if you need to turn around and sell it, you can. Another money-saving advantage of owning the car may include getting a better rate on your car insurance due to not needing to insure it so heavily. Most auto lenders require you to carry collision and comprehensive insurance to protect their investment. However, according to Experian,² when you pay off your loan and own your car outright, you can choose whether to carry these coverages, and as a result, your premiums could drop.

3. Free up your money. The average monthly car payment was $700 for new cars and $525 for used cars in Q3 of 2022, according to Experian.³ Meanwhile, a study conducted by Edmunds.com⁴ concluded that a record-breaking 15.7% of consumers who financed a new vehicle in Q4 2022 committed to a monthly payment of $1,000 or more. Use your freed-up money for other financial goals instead. Without a car payment, you can divert that money to other things, such as savings. Furthermore, if the interest rate on your car loan is higher than what you could earn by investing, then paying off your car early and using that money to invest can pay dividends on your path to financial wellbeing.

4. Your debt-to-income ratio improves. Your debt-to-income ratio⁵ represents how much debt you owe versus the amount of money you make. Future lenders will reward your lower debt-to-income ratio with a better interest rate when you look to finance a large purchase down the road.

Pitfalls

While there are many advantages to paying your auto loan off early, there are circumstances when that may not be the case. Here are some instances when you may want to resist paying off your car too soon:

1. Your loan has a prepayment penalty. A prepayment penalty is a fee that some lenders charge if you pay off all or part of your loan early. For example, suppose your lender charges a penalty fee for paying off your loan before the end of the loan term. If the fee is more than any interest savings you would realize from paying off the loan early, doing so may not be in your best interest. Check your financing documents or talk to your lender to see if your loan is subject to a prepayment penalty.

Financing companies make money from your loan interest payments. When you finish paying, they no longer receive that interest, thus many of them charge these prepayment fees. If you or someone you know is in the market for a new auto loan, make sure to read the fine print for fees and penalties. Affinity Auto Loans⁶  have no prepayment penalties and zero application fees. They'll even throw in an extra APR^* discount when you enroll in automatic payments.

2. Your money may be better spent somewhere else. If you have credit cards with higher interest rates than your car loan, consider paying down those higher-interest debts first. Just as pertinent—if paying your loan off early means emptying your savings account, then it's probably best to avoid that at all costs. Remember—it's essential to never leave yourself in a vulnerable financial position without a safety net. Having a fee-free, high-yield savings account for a rainy-day fund, like Affinity’s SmartStart Savings⁷, can give you peace of mind when something unexpected arises.

3. You can’t afford it right now. If you make a larger lump-sum payment to pay off your car loan you may strain your budget, making it difficult for you to pay your other bills. As long as your auto loan has a reasonably low-interest rate, you don’t want to jeopardize your whole financial situation and cause financial hardship to yourself. Be sure to look at the big picture of your financial situation before deciding to pay off your auto loan in full.

4. You don’t want to affect your credit score. With your auto loan, you are building a history of on-time loan payments, which helps your credit score. Consequently, when debt is paid off in full, people often experience a dip in their credit score due to the track record of making on-time payments coming to an end. This action lowers both your credit mix and number of open accounts. However, if you continue managing your accounts responsibly, the dip in your credit score should be minor and temporary. As long as you are not planning on making a large purchase like a home, where you want your credit score to be as high as it can be, you should be able to weather this short-term credit score decrease, according to Forbes.⁸

If you need to hang on to cash for upcoming expenses, don’t have a big enough emergency fund, or have higher-interest debt you need to pay off first, then it is not the right time for you to pay off your car loan—and that’s OK. Continue making your auto loan payments on time; you'll be finished before you know it.

Sidebar: Ways To Pay Off Your Car Loan Early

Depending on your monthly cash flow, you may want to consider one of these strategies:

• Make one lump-sum payment. Call your lender for the payoff amount (which may include interest and fees) to ensure you’re paying the right amount and for any specific directions for submitting the payoff payment.
• Add a little extra to each payment so you’ll finish sooner. Call your lender to confirm that any extra money you send will apply to the loan’s principal.
• Make a large extra payment every year. If you have received a windfall—maybe a bonus or tax refund—you can apply it to the principal of your auto loan. You’ll be surprised by the difference it will make in paying the loan off sooner.
• Make a half-payment every two weeks. This results in 13 total payments per year instead of only 12.
• Round up your car payments to the nearest $50 or $100. For example, if your payment is $461, then round up to $500.
• Refinance your car loan for a better interest rate and shorter term. Be sure to shop different lenders to get the best rates. Remember, credit unions like Affinity often have competitive rates⁹ and flexible terms on auto refinancing.

This information is for informational purposes only and is intended to provide general guidance, and does not constitute legal, tax, or financial advice. Each person’s circumstances are different and may not apply to the specific information provided. You should seek the advice of a financial professional, tax consultant, and/or legal counsel to discuss your specific needs before making any financial or other commitments regarding the matters related to your condition.

*APR = Annual Percentage Rate. All loans are subject to credit review and approval.

1. Credit Karma
2. Experian
3. Experian
4. Edmunds.com
5. Investopedia.com
6. Affinity Auto Loans
7. SmartStart Savings
8. Forbes
9. Affinity Rates and Yields