Why Payoff A Loan Early?
Debts weigh down your monthly budget. If you repay a loan early, you’ll enjoy many perks.
One of the most lucrative benefits is saving a hefty amount on interest payments.
Still, interest rates can be impacted by prepayment fees and other charges.
Thus, you should check with the lender before you start paying back more than agreed.
Let’s say you borrowed $10,000 at 14.99% APR for a five-year term.
When you pay the basic monthly installments, you will end up paying $4,271 for interest alone.
However, if you added just an extra $50 per month on the monthly payment ($238), you could have paid off the loan at least 14 months before the estimated term and saved almost $1,075 in interest.
Some other notable benefits of paying off a loan early include:
- More financial stability and better control over your funds
- Saving money that you would have otherwise paid as interest
- Lowering your debt-to-income ratio
- Reducing the car’s insurance cost
- Using surplus funds to clear other debts
- Gaining peace of mind
What Are The Penalties For Early Loan Repayment?
There are different loan prepayment penalties set by lenders.
In case of auto loans, these penalties are mostly governed by state authorities.
Penalties are typically determined by multiplying the predetermined percentage by the total outstanding.
More than 70% of US states allow these types of penalties.
You could end up with prepayment penalties or a pre-calculated interest if you have a bad credit score or weak repayment history, so be especially cautious.
If you’re thinking of paying off the loan sooner, keep the following in mind:
- You’re most likely to incur a penalty if the loan term is under 48 months
- Lenders can’t charge prepayment penalties on all loans with terms longer than 5 years across the US
- Check the original contract if it has the prepayment penalty cause
- Verify the interest rate and consult the lender to understand if it is pre-computed or follows the Rule of 78s
For example, you have a car loan of $10,000 for 60 months at 14.99% APR. By the 4th year, you want to clear the loan.
Let’s say the current balance outstanding is $4,700 and the terms signify a pre-calculated charge of 25% on the total of principal ($4,700) + final year’s interest ($1,090).
This means, to prepay the loan, you’ll pay a penalty of almost a thousand dollars or more.
When Is It Best And Worst To Repay An Auto Loan Early?
Although repaying an auto loan early is totally worth considering, it isn’t a perfect fit for every scenario. You should consider an early payoff if:
The auto loan has a higher rate of interest
If you have a loan term that’s 5 or more years, you’ll possibly pay more than the value of the car.
Since there are no penalties for long-term loans, considering early payoff can help you save a lot of money.
You’re seeking a new loan and need to improve the DTI-ratio
Lenders review your income versus expenses before approving your application.
If you’re looking for a bigger loan like a home mortgage, prepayment can help you maintain a lower debt-to-income (DTI) ratio.
You have surplus funds
If you don’t need to compromise your or a dependent’s lifestyle, this might be a worthwhile option.
There are no other immediate debts
If you want to free up money for future use, this is a possibility.
On the other hand, consider holding off the prepayment idea if:
- You don’t have enough backup funds for emergency needs
- You have other outstanding loans with higher rates
- The loan term is less than 48 months
- Your loan agreement has pre-calculated penalties on prepayment
- You’re very close to pay off the outstanding as per the terms
What Is The Best Way To Save Money On An Auto Loan?
The recommended way is to start safe.
Whenever you apply for an auto loan, make sure that you ask for a simplified loan and not a pre-calculated loan.
This will help you steer clear of possible prepayment penalties.
Once you weigh the pros and cons, and feel that prepayment is a good idea, here are a couple of ways to save money:
- Try making one payment. Check with the lender for the payoff amount. Usually, this payoff amount will include all interest/fees and the principal.
- Make bigger payments than the minimum amount. Any extra amount you pay lowers the principal, which further lowers the interest.
- If you’re paying a high interest rate on an auto loan, try opting for refinancing. Based on a credit score and other aspects, you can possibly access a lower rate.
An early auto loan payoff is a great option, but it doesn’t suit everyone’s needs.
There are many cases where borrowers end up paying more than they bargained for because of prepayment penalties.
It is important that you discuss the loan terms with the lender and consider other options like refinancing before choosing this route.