Yes, you can pay off your car loan early. However, a better question is whether you SHOULD do so.
There will usually be a cost associated with the early repayment of a car loan and ideally the savings in the future would outweigh these costs.
But there is much more to consider than this. What if you are applying for a mortgage? What would that extra cash flow do to your borrowing power?
In this article, we will explore these questions and walk you through how to calculate the difference between paying your car loan off early and staying the course so you can decide for yourself.
In This Post:
Do Car Loans Have Early Repayment Fees
Most car loans include an early repayment fee in the loan agreement.
There are very few lenders who do not include a break fee as part of a standard contract.
If you prefer a car loan where the exit fees are low, or none at all, then get in touch with our broker team below to discuss what lenders may be suitable for your circumstances.
Why Do Lenders Charge Early Repayment Fees?
Lenders price their loans based on the full term of the agreement. If you repay the loan early you will save money, which also means the lender makes less!
A lender needs to have a mechanism in place to recoup some of the lost future income of that loan, and the administrative cost of closing down the loan early.
There are some lenders who do not charge this fee, but very few.
How to Check Your Early Repayment Fee
All fees associated with a loan are included in the loan agreement.
Assuming that you have saved a copy, all you need to do is open the document and find the fee schedule.
If you do not have a copy then you can just call your lender and ask what it would cost to pay out your loan.
Some lenders may have an online calculator that will provide some guidance on your payout figure but these are indicative only and may not be accurate for your specific loan.
Can You Negotiate The Early Repayment Fee
Most things in life are up for negotiation. However, in this circumstance, you may not have much leverage.
If you are refinancing your loan with the same lender to either extend your repayment term, lower your repayments, or avoid a balloon payment, then perhaps they will be ok to waive the fee.
This is because they stand to profit from the refinance.
But if you are paying off your loan, and that’s the end of your dealings with that lender then you are unlikely to avoid an early repayment fee.
Should You Pay off Your Car Loan Early
Usually, you should only pay off your car loan sooner if the savings outweigh the cost of any early exit fees.
There are a range of other reasons that may outweigh the financial aspect and we’ll get to those in a moment.
First, let’s understand the mechanics of the payout.
Calculate Your Potential Savings First
Your savings will be much larger if you are paying out your loan in the second year rather than the fourth.
Let’s consider the following example:
- Loan Scenario: $30k loan $12% interest repayable over 5 years.
- Balance after 2 years: $20,553 remaining payable over 3 years.
The remaining cost of repaying the loan is $4,022.30.
This amount is likely to far exceed any early repayment fees – which are usually around the $500 to $750 mark.
Case Study
Let’s take a look at how your savings evolve over the course of the loan term.
We’ll use the same example as above, and for simplicity lets ignore any monthly fees that may be applicable (another common cost of a car loan).
| Remaining Term | 4 Years | 3 Years | 2 Years | 1 Years |
|---|---|---|---|---|
| Future Cost | $6,948.23 | $4,137.80 | $1,986.55 | $578.09 |
| Exit Fee | $750 | $750 | $750 | $750 |
| Net Savings | $6,198.23 | $3,387.80 | $1,236.55 | -$171.91 |
As you can see, the net savings of paying your car loan early outweigh the penalty fee that may be imposed.
Even up to that final year, the fee is only marginally higher than the money you will save.
So if there are other motivating factors in most cases any loss will be marginal until those last few months of your loan term.
Benefits of Paying Out Car Loan Early
Save Money on Your Car Loan
The less time you spend paying interest, the more money stays with you. Even small additional repayments can significantly reduce the total interest paid over the life of the loan.
Free Up Cash Flow
If you are applying for finance elsewhere then removing that regular car loan payment from your budget can improve your situation considerably.
When calculating your maximum borrowings on a mortgage for example, the payments on a $30k loan could potentially support an extra $100k+ if put towards a mortgage.
Imagine what that does for your home-buying prospects.
Improve Credit Score
Your credit score is a reflection of your past behaviour in managing credit. Since Comprehensive Credit Reporting was introduced in Australia, a lender can see the status of your past loans at every stage.
If they were ever in arrears this would be visible. If they have been repaid this will also be visible!
Guess which one would appear more financially responsible to a future lender?
The longer the track record of uninterrupted positive repayments on credit-related products the more your credit score can increase.
A higher credit score can provide you with more options for cheaper interest rates next time you apply for a car loan.
Own Your Car Sooner
Have you ever tried to sell a car privately that was under finance? It is possible but creates a few extra steps and is a hassle.
Once you own your car fully you can do whatever you want with it, whenever you want. There will be no security registered that to potentially slow you down.
Be Debt-Free Sooner
In the example above, once you have repaid the loan in full you have $622 back in your pocket ($722 if you are paying extra!).
However, aside from the extra money you will have there is an unquantifiable peace of mind aspect that comes from not having the pressure of repayments coming out on payday.
If you can stay disciplined and make those extra repayments then you can pay off your car loan sooner!
Conclusion
You can pay off your car loan early if the benefits outweigh the cost.
This can be a financial, or personal benefit. Either way, there is a lot to be said for getting out of debt sooner rather than later.
Just remember to calculate your early repayment costs and compare them to the savings you will make over the remaining term of the loan.
Then you can make an informed decision on whether you will pay off your car loan early or not.
