Congratulations on your windfall! You know you are an adult when you plan to pay off your car loan rather than going without for fun but frivolous things. You may want to think twice before you pay off your loan, especially if you consider its potential impact on your credit scores. Here are the advantages and disadvantages of paying off your car loan sooner than expected.
Check the fine print of your auto loan
Be sure to check your loan details before making any additional payments beyond the required monthly payment. Even if you decide to only pay off a larger portion of your loan, you want to make sure you pay off the principal, which is the amount borrowed, and not just make payments up front. Bottom line: call and speak with your lender.
After talking to your lender, you should know the pros and cons of prepaying your loan.
- Give yourself the freedom: every time you pay off debt, it gives you the opportunity to give yourself more freedom to do… well, what you want… without having to go into debt. So if you get rid of those car payments and the interest charges that go with them, you can put that money aside and save for your next car, which you can hopefully buy without taking out a loan.
- Lower your auto insurance costs: Lenders require comprehensive insurance coverage. Take a closer look at your comprehensive and collision coverage and see where, or if, you can make adjustments.
- Don’t expect a big increase in your credit rating – wait what? Many people understand that paying off their credit cards is a great way to improve their credit scores, and they are right. But auto loans are different. While credit cards are revolving loans (meaning you charge and pay them off over and over again), auto loans are installment loans (meaning you get a fixed amount and pay it back, it is done). So when you pay off an auto loan early, you are actually losing the opportunity to show the credit bureaus that you are good at paying your bills on time. Well-managed loans with timely payments show that you are effectively managing your credit now rather than in the past. It all wraps up in your FICO scoreSo paying off that loan early won’t necessarily hurt your credit score, but it is unlikely to help either.
- It might not be as simple as you think – some lenders’ contracts don’t just allow you to pay off the loan before the contract ends. Lenders lose money when a loan is paid off earlier than expected. Don’t be surprised if to pay off the loan early you have to add an extra month of payment or let them name your firstborn (joke). Check if you have the possibility of refinancing the loan then repay.
- Other investment options may offer better returns: Current auto loan rates are relatively low (you can compare auto loan rates and find one you are likely to qualify for on Experian.com. If you are locked into a voucher, it may be worth considering other investment opportunities with your new money. Call your financial advisor and see what happens. Or if you have credit card debt with higher interest rates, you might want to invest your money to pay it off.
While limiting your debt-to-debt ratio is always a good thing, it’s important to understand the details and nuisances of your personal car loan before deciding to pay it off. Check out some of the details above and develop a strategy that will make your money work harder for you. Oh, and congratulations on the money!