Yes, you can pay off a car loan early to avoid interest. When you make your monthly car loan payments, part of your payment goes toward the principal, or the amount borrowed, and the rest goes toward interest and any additional fees, which is the cost of borrowing. Depending on the loan terms, you may be able to avoid interest when paying off the principal balance early.
Saving on interest will depend on whether you have a simple or precomputed interest loan. With a simple interest loan, you are paying interest based on the amount owed at any given time. This means that the sooner you pay off the loan, the less you will spend on interest payments. However, with a pre-computed interest loan, your interest is calculated upfront at the start of the loan. This means that any interest you pay is fixed, so if you pay off the loan early, you may still be responsible for the remaining interest.
Pros and Cons of paying your car loan early
While paying off your auto loan early is certainly one way that you can save on interest over time, there are a few things that you’ll need to consider before you make the decision.
Some auto loans may have a pre-payment penalty, which is a fee you are charged when the loan is paid off early. If your loan has pre-payment penalties, you’ll need to consider whether the benefits of paying the loan off early outweigh the fee costs.
Handling Additional Debts
You’ll also want to consider what other debt you have, such as credit cards, personal loans, student loans, and others. If any of these debts have a higher annual percentage rate (APR) than your car loan, then you may want to focus on paying these balances before paying off your auto loan as a more effective way to save more on interest.
The Effect on Your Credit Score
While paying off your auto loan early won’t hurt your credit score, making payments in full and on time each month can have a significant positive impact on your credit. If you don’t have other accounts on your credit report or your auto loan is the oldest account, you may consider keeping it as a way to build a better credit history.
Balancing Your Monthly Budget
Before you pay off your car loan early, you should consider how making this large payment will impact your budget. Will paying the loan off early leave you unable to afford your other monthly bills? If so, you may want to pay a little more than the minimum payment each month instead of paying it off completely.
If you’ve decided that you want to pay your car loan early to avoid interest, there are a few different ways you can go about it. You can make one large lump sum payment, make multiple payments a month, or just pay more than the minimum each month. These strategies will help you save on interest payments over time.
Paying your car loan early to avoid interest
This may or may not be a wise financial decision. As you can see, the first thing to consider would be any penalties. If you're not sure, you can call your lender and find out about that.
Then there's the question of what's the best use for that money. Paying off a loan to avoid paying the interest doesn't make financial sense if it means you'll have to go into more debt on another front.
Get your numbers and write them down. Consider other debts, your overall monthly budget and any penalties you might have on early payments. Now try and see what happens if you do pay your car loan early - and what happens if you don't. Figure out which situation leaves you with more and follow that route. Don't be afraid of the interest your paying. Sometimes a small interest on one loan is in fact the better route to take.