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Is a Long Term Auto Loan a Good Idea If You can Pay It Off Early?

An auto buyer at a dealershipAn auto buyer

Are you in a hurry? Well, in a nutshell, paying off long term auto loans early brings benefits such as reducing the amount of interest you own while also freeing up some money in your monthly budget for savings or expenses.

With that said, we'd recommend taking out some time from your busy schedules to read this entire post so you know exactly what factors to consider before paying off your auto loan earlier than your lender anticipated.

Should You Pay Off Your Auto Loan Early?

Maybe you've found a little extra income per month or you recently added a large amount of money to your bank account. Now, you're probably wondering whether you should use this amount to short your loan payoff period.

You're thinking about doing so because there are some obvious benefits of doing so and these include:

Helps You Save on Interest

Your monthly payments to your lender are meant to gradually pay off the principal amount you borrowed and the interest (or any fee that's part of your loan terms), since these are the costs of borrowing finances. However, depending on the terms of your contract, you might be able to reduce the interest you owe by paying off the principal amount early.

For instance, if you opted for a $20,000 loan at a 5% interest rate and a 60-month repayment plan, you will have to pay $22,645 per month. This includes $20,000 for the principal and $2645 will be your payment against interest accrued per month.

If you pay off this auto loan early, then you could save on all the $2645 interest payments that were accrued for the remaining months. This relatively simple strategy might get a little confusing, however, if you move from simple interest to pre-computed interests for auto loans.

For simple interest, you pay the interest you owe for any given month you still owe the principal. For this reason, if you were to pay off the principal early, you could save hundreds of dollars. If, say, you pay off the entire principal amount of $20,000 in 4 years, you will have paid $2108 for interest, which is $537 lower than what you would have paid otherwise.

On the other hand, if you are working with pre-computed interest, your accrued interest is calculated right at the start of the loan and hence your interest payments are fixed. This means that even if you pay off the principal early, you will still be liable for the full interest on the loan.

Frees Up Funds for Other Expenses

If you plan on paying off your auto loan early, then you will eventually free up extra money from your monthly budget. This could be used to pay off other debts such as student loans or mortgages or perhaps even to build your own emergency fund.

You Can Avoid Paying More Than Your Car's Worth

According to a report published in 2018, the average car-loan term has now moved up to just under 6-years. If you are also dealing with a long-term loan, it is highly likely that you are paying more than what your car is actually worth, thanks to its depreciation rate. When this happens, you'll have negative equity for your car, which is also referred to as being ‘upside down with your car loan'.

Paying off your car loan earlier than anticipated can help you avoid this risky point in time and have stable finances by the time your car reaches this point in depreciation.

What to Consider Before Paying Off Your Auto Loan Early

Even though it seems as if paying your car loan early is a great method of saving money in the long-term, it is not necessarily applicable to every situation. For this reason, here are some of the most important considerations before you try to pay off your long-term loan early:

Prepayment Penalties

Some auto loan lenders prefer to add a prepayment penalty to your loan terms. This penalty is a fee that will be charged to you if you plan on paying off the loan earlier than anticipated. For this reason, it is important that you read the terms and conditions of your lender's loan contract before trying to do so. Even if your loan terms include this penalty, you should weigh the financial benefits of doing so against the short-term cost of the penalty. Now ask yourself, is the penalty worth it?

Other Debts

Think about the other debts you currently owe, such as personal loans or credit card debts. If any of these loans have a higher annual percentage rate than your auto loan, then we strongly suggest paying down these lenders to save your money on those large interest payments.

Your Credit Score

Paying all your bills on time plays a huge role in determining your credit worthiness. Now paying off your long-term auto loan may be good for your credit score but keeping the account open with timely payments may improve your credit score more.

If, for instance, you auto loan is the only liability in your credit report, or the older account, then it could actually be beneficial for you to maintain timely payments and not pay off the loan early.

Don't Know How to Pay Off Your Auto Loan Early?

Once you've weighed the benefits and drawbacks of paying off an auto loan early, you can decide how it makes sense in your situation. For instance, one way of paying off your car loan is to refinance with a better credit score and then pay this new loan off with your available finances (because of a better APR and better financial position).

Before we end this post, we'd like to give you an example of the best auto refinance rates from our research. However, you could conduct your own research to compare the latest data.

Auto Refinance Rates and Lenders (Sep 2020)

Minimum Credit Score Estimated APR% Loan Amount
Lightstream 660 3.99%-9.99% $5000-$100,000
MyAutoLoan 575 2.05%-29.40% $5000-$99,000
RefiJet 580 2.45%-17.99% $7500-$150,000
Rate Genius 550 1.99%-16.00% $12,000-$100,000
AutoPay 600 1.99%-17.99% $2500-$100,000

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