The primary purpose of a car loan is to provide you with means to access credit that allows you to purchase a vehicle that otherwise would not have been within your reach. It could be because the purchase price is more than you can initially afford, or, your cash flow dictates that you need to pay the car off over time.
But what happens when you find yourself in a position to pay off the car in entirety ahead of schedule? Should you repay your car loan early using your savings? Those looking for a ‘yes’ or ‘no’ answer will be disappointed to know that it is a much more complicated matter. What works for one person won’t necessarily work for another. For example, do you have other debt that you might need to pay off first? That’s all the more important to consider right now with interest rates rising.
Let’s consider the potential upside and downside.
The upside of paying your car loan early using your savings
Few things feel better than the financial freedom that comes with being debt free. More specifically, these are some of the benefits that come with paying down your car loan early:
- No more interest costs – by repaying the loan early, you effectively end all interest related costs that come with the car loan. Over the course of the loan this could potentially save you thousands in dollars, ultimately making the cost of the car less than it would have been if paid over the term of the loan
- Reduced debt – with the loan paid off you will be in a better financial position as far as owing less (or even zero) debt. At the very least this is a huge weight off the shoulders for many people, but beyond that, this could be beneficial should you wish to leverage your assets against another loan
- Improved credit history – being able to demonstrate a reliable history of repayments and the ability to repay the loan in full will enhance your credit history. These days credit reports do not only contain ‘negative’ events, but also take into account ‘positive’ ones
The downside of paying your car loan early using your savings
From a financier’s perspective, if you repay the loan early, they no longer earn interest on the balance of the debt. It is not uncommon for lender’s to impose financial ‘penalties’ to discourage you from repaying the loan early, or to cover their lost earnings. As such, disadvantages include:
- Early repayment fees – your contract will stipulate the extent of these penalty fees and they can be quite significant. Depending on timing, in some instances it may actually be cheaper to continue paying the loan according to the schedule, or even refinancing it, as interest costs could be less than the fees associated with exiting the loan
- Cash flow – if you manage to repay the loan early you will want to be certain that your cash flow is not likely to be restricted by the lump sum payment being made. In essence, repaying your loan early is only suitable for certain individuals who can afford to do so
The Fincar team is here to help you with all your financing needs. Contact us today to help arrange your next car or equipment loan.