Paying a car loan off early
The honest answer to "should I pay it off?" depends on four or five other answers, so this page asks them in order. Open the branch that matches your situation and keep going until you reach a leaf.
Everything below assumes you either have a lump of cash that could clear the loan, or spare money each month that could go toward it. Open a branch with a tap. Branches you don't open stay out of the way, and nothing is decided until you reach a colored leaf.
StartI could put extra money toward my car loan. Should I?
Would it leave you without an emergency cushion?Money sent to a loan is gone. The lender won't give it back when the transmission fails; the monthly payment is due regardless.
YesPaying it off would drain my savings.
Build the cushion first. An early payoff saves interest, but a cash emergency with no savings tends to get paid for with a credit card or a missed bill, both of which usually cost more than the car loan does. Once your savings would survive the payoff with room left, come back to the top.
NoMy cushion stays intact either way.
Do you have other debt at a higher rate?Credit cards, personal loans, anything whose APR is above the car loan's.
YesSomething else charges me more.
A dollar sent to the most expensive debt saves the most. Keep paying the car loan on schedule and aim the extra money at the higher-rate balance until it's gone, then return here. The car loan also has a quiet advantage: it's secured by something you need, so it's usually the debt people protect most carefully anyway.
NoThe car loan is my most expensive debt, or my only one.
Does your contract use simple interest, with no prepayment penalty?Look at the prepayment wording in your contract, or ask the lender in writing. The answer decides whether paying early actually saves anything.
No / not surePrecomputed interest, a penalty, or I can't tell.
With precomputed interest, the total finance charge was set at signing and an early payoff may refund only part of the unearned interest, by whatever method the contract specifies. A prepayment penalty, where one applies, eats into the savings too. Ask the lender for a written payoff quote and compare it with the sum of all your remaining payments. The difference is what paying off today would really save. If it's small, the case for paying early is weak; if it's meaningful, continue down the "yes" branch.
YesSimple interest, no penalty.
Is the loan's APR higher than what that cash would reliably earn, after tax?Compare against where the money would otherwise sit safely, a savings account or similar, not against a hoped-for investment return.
An illustrative scale: $15,000 left on a simple-interest loan at 6% APR, with 36 payments of $456.33 remaining.
36 × $456.33 = $16,427.88 still to pay
$16,427.88 − $15,000 = $1,427.88 of interest avoided by paying off today
Your real payoff quote will differ slightly, because interest accrues daily between payments. Set the $1,427.88 against what $15,000 would earn over those three years, after tax, and you have the comparison in dollars.
NoMy savings earn about as much, or more.
On the numbers, keeping the cash and paying on schedule costs you little or nothing, and the cash stays available. That said, a paid-off car has value the arithmetic doesn't capture: one less bill, one less lien, full freedom to sell. If that peace of mind is worth the small difference to you, it's a legitimate reason. Just don't let the paid-off feeling pull your savings below the cushion from the first branch.
YesThe loan costs clearly more than my cash earns.
All at once, or a bit extra each month?Both save interest; a lump sum saves it sooner, extra monthly payments keep more flexibility. How an auto loan payment is built shows why extra principal sent early in the loan does the most.
Lump sumClear it in one go.
- Request a written payoff quote with a good-through date. The figure changes daily.
- Pay by a traceable method before that date, and keep the confirmation.
- Confirm the account shows a zero balance and is reported as paid in full.
- Watch for the lien release or title. How and how quickly it arrives varies by state and lender; if nothing comes, ask the lender and check with your state's motor vehicle agency.
- Tell your insurer the loan is gone so the lienholder is removed. Your coverage choices are yours now, though when dropping collision makes sense is a separate decision worth making deliberately.
- If you bought gap coverage or a service contract with the loan, read their cancellation terms. Some provide a partial refund of unused cost; gap in particular has no job left once the loan is gone.
Monthly extraChip away at it.
- Ask the lender how extra payments are applied. Some treat extra money as an early payment of next month's installment rather than a reduction of principal, which saves far less.
- Use whatever mechanism the lender provides to mark extra money as principal-only, and keep doing it every time.
- Check the next statement: the principal balance should drop by the full extra amount.
- Keep making the regular payment in full and on time. Extra payments generally don't let you skip one later unless the lender says so in writing.
- Revisit the top of this tree once a year. Circumstances change, and the cushion question comes first every time.
If you reached a leaf you didn't like, that is useful information too. Most of the "not yet" branches are about order rather than refusal: savings first, costlier debt second, the car loan after that. The day of the month you make payments has a much smaller effect than any of this, as the day-by-day figures in why the day you pay can matter show.
Keep reading
Further reading
- Prepayment penalties Investopedia
- Amortization schedules Investopedia
- Auto loan key terms Consumer Financial Protection Bureau