Should I pay off car loan? (2024)

FAQs

Should I pay off car loan? ›

Key takeaways

Typically it is a good idea to pay off your car loan early if you have solid personal finances or if you are looking at making a significant purchase in the near future. However, this is not always the case and lenders may have barriers for doing so.

FAQ about paying off a car loan early and your credit

In the short term, paying off a debt and closing credit accounts can result in a drop in credit scores. But over time, it can improve a person's DTI ratio, which lenders may look at when considering your credit application.

When you think about how much you'll owe in interest by the end of your loan term, you might think: “Wait… can I pay off my car loan early to avoid future interest?” The answer is yes. In fact, paying off your car loan before the end of the loan term is a great way to reduce your interest payments!

According to our research, you shouldn't spend more than 10% to 15% of your net monthly income on car payments.

Keep in mind that your actual monthly car payment won't change even if you pay extra for a period of time. You'll just repay the loan sooner and save some interest.

Because of the high interest rates and risk of going upside down, most experts agree that a 72-month loan isn't an ideal choice. Experts recommend that borrowers take out a shorter loan. And for an optimal interest rate, a loan term fewer than 60 months is a better way to go. You can learn more about car loans here.

Once you pay off your loan, your lienholder will send you an official release of lien letter. You'll take that to your state BMV or DMV (or, in some cases, to your local city/town clerk's office) along with your current title and apply for an updated title.

It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.

It might reduce the types, or 'mix,' of credit you have

Let's say you just made the final payment on your car loan. Your payment history is perfect and you keep credit card balances low. But now you have one less account, and if all your remaining open accounts are credit cards, that hurts your credit mix.

What are the disadvantages of paying off a car loan early? ›

When you pay off your car loan early, your debt will become smaller. This is positive for your credit history but might lower your credit score slightly because you're no longer logging on-time monthly loan payments. Once you pay off the loan, you will no longer have positive payment history for that long-term loan.

Some may have a prepayment penalty — a fee for paying off a loan early or making extra payments. This is especially common with auto loans that use precomputed interest. On average, the penalty is about 2 percent of your outstanding balance. So, if you have $7,000 remaining, you would have to pay $140.

Those will become part of your budget. The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.

The average monthly car payment is now a record $733, according to Edmunds. And even if your monthly auto loan payments are around $500 per month, that still may be uncomfortably high. And that's before adding up the cost of maintenance, fuel, and auto insurance.

To apply this rule of thumb, budget for the following: 20% down payment: Aim to make a 20% down payment on your new car. 4-year repayment term: Choose a repayment term of four years or less on your auto loan. 10% transportation costs: Spend less than 10% of your total monthly income on transportation costs.

In most cases, you can pay off a personal loan early. Your credit score might drop, but it will typically be minor and temporary. Paying off an installment loan entirely can affect your credit score because of factors like your total debt, credit mix and payment history.

Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio. While in some cases your credit scores may dip slightly from paying off debt, that doesn't mean you should ever ignore what you owe.

Consistently paying off your credit card on time every month is one step toward improving your credit scores. However, credit scores are calculated at different times, so if your score is calculated on a day you have a high balance, this could affect your score even if you pay off the balance in full the next day.