If you find yourself wondering how paying off your car loan earlier than intended could provide benefits, you’ve come to the right place. Read on to learn more about early car loan payments and what they could do for you.
Can you pay out your car loan early? Are there consequences?
Yes, though it is possible to pay out your car loan early, there may be certain fees or penalty charges for doing so. You can find the specific fees outlined in the terms of your agreement with the lender or reach out directly to your lender.
Lenders are required to explain in either their contracts or terms and conditions any fees and charges involved in paying your loan out early, along with all the other features on your loan, such as interest rate, establishment fees, origination fees and any other charges and ongoing fees.
If you have a variable rate car loan, there are likely fewer fees or penalties associated with paying out the loan amount earlier than the full term. For those with a fixed car loan, however, you may see higher break costs, as lenders will try to regain potential future repayments.
How can you pay off your car loan early?
There are several ways you may pay off your car early. This includes making additional payments, such as: There are two main ways to make additional payments:
- Additional monthly repayments – This means paying more than your required monthly repayment amount. Or you could also make more frequent payments per month.
- Lump-sum payment – This involves paying the full amount of the remaining loan balance back at once.
Making additional payments each month will help you pay back your debt fast over time, while a lump sum payment lets you out of your car loan immediately as long as you pay off the full outstanding balance. If you have a balloon payment, you must consider that when paying off your car loan early, as it can affect the outstanding loan balance.
Benefits of paying off your car loan early
Even with potential fees, paying off your car loan earlier than the loan term has certain advantages, such as:
Save money on interest payments
Paying out an auto loan early can save you money on future interest repayments. This means lowering the overall cost of the loan, as well. You may incur a few fees by exiting your loan early, but the potential interest savings could outweigh the costs.
Free up cash flow
If you’re able to pay off your loan earlier, a portion of your income won’t be tied to making repayments. It frees up your money for additional savings or to put towards other expenses. This could also improve your debt-to-income ratio.
If you're managing multiple debts, clearing at least one can help put more towards other debts you need to repay.
Reduce the possibility of negative equity
Negative equity occurs when your car loan’s outstanding balance is greater than the vehicle’s current market value. Car values depreciate quickly, especially when you rack up the miles on your odometer every year. Paying off your car loan early could be a good way to avoid that.
You’ll own your car outright sooner
As most car finance is in the form of a secured loan (your vehicle is used as security), you don’t own your vehicle outright until you’ve paid off your loan in its entirety, which could take years. If you pay off your car loan early, the ownership of the car is officially transferred to you.
Disadvantages of paying your car loan off early
There are also some downsides to paying off your car loan early, which are:
Early exit or break fees
The biggest downside to early repayments is the possible additional costs, like exit and break fees. These charges will vary depending on the lender and type of car finance you have, but they can end up being substantial.
Reduce your savings
Just because you can pay off the remaining balance doesn't necessarily mean you should. It's important to weigh up costs and do what makes sense for your personal financial circumstances. Before deciding, it's always best to seek independent and professional financial advice.
Why are there penalty fees for paying back a loan early?
It has to do with how your loan’s interest is calculated. With most fixed rate car loans, interest is calculated on the daily balance, charged monthly in arrears. The interest is calculated on the outstanding balance of your loan every day and then added up over the month to calculate your monthly interest payable. Therefore, any additional payment would reduce the outstanding balance and interest payable on that given day and for the days moving forward.
When you pay your loan out early, any outstanding interest from that day forward would not be payable. This is why you save on interest when you make early payments on your car finance. If you ‘break’ the loan early, lenders, in most cases, will require borrowers to pay an early exit fee to recover any costs they may lose.
Car loan early exit costs are usually a set amount that reduces the longer you keep the loan, and may have a small discharge fee.
Want to learn more about car loan payments?
Get in touch with the car finance brokers at CarLoans.com.au by calling 1300 889 669! They’ll be more than happy to discuss your car loan needs and find the best finance solution for you. Or you can get a quote online!