Should You Pay Off a Car Loan Early?
If you have a simple interest car loan and there’s no early payment penalty, paying off a car loan can be a great way to save money in the long run by avoiding interest. That doesn’t mean paying off your auto loan early is always the best thing to do for your finances.
The best option for you is dependent on your financial and life situation. What if a person who still owes $10,000 on their car gets a $10,000 end-of-the-year bonus from their employer? If the auto loan is their only debt, it may make sense to pay it off early. However, if they are carrying a balance on a high-interest credit card or have outstanding student debt, that bonus money might be better spent elsewhere.
In most cases, if you have several different debts, you should pay off the ones with the highest interest first. For example, if your auto loan is only 3.64 percent and your student loans are 5.8 percent, it probably makes more sense to put money towards your student loan principal rather than paying off your car loan. In that scenario, it’s costing you more to borrow money for tuition.
Why Do Some Auto Lenders Penalize You for Paying Off Your Car Loan Early?
Lending money is a massive business. Companies that offer auto loans profit from the interest they’re paid. Consider a scenario in which you:
- Buy a car for $30,000
- Put down $6,000 (20 percent)
- Get a 72-month loan (six years)
- Have a seven percent interest rate
After six years you will have paid $29,460.68 – $5,460.68 of that will be interest. That interest is essentially the money you paid the lender for the privilege of borrowing the initial $24,000. If you get a bonus from work or decide to consolidate debt and pay off the principal you owe one year into the term, your lender will have made less than $1,000 instead of nearly $5,500.
Some lenders want to discourage that, so they include prepayment penalties in their loan contracts or structure their loans to prevent that type of early payment.
Different Types of Prepayment Penalties and Auto Loan Structures
Your auto loan contract could stipulate a penalty based on a percentage of your loan’s balance. These have a façade of fairness because the penalty you pay gets smaller as the loan balance shrinks. The dollar amount you’ll owe if you pay off your loan five years early will be significantly higher than what you’d owe if you finished paying off your loan a year early.
The Rule of 78s loan strategy conveniently circumvents the entire concept of a penalty by ensuring a significant percentage of your initial payments goes toward interest instead of principal. Even if you do end up paying off your car loan two or three years into the six-year term, your lender will have already been paid much of the projected interest.
Precomputed loans are similar to the Rule of 78s in that you can’t really dodge the interest. In the contract, you’re agreeing to pay both the interest and principal. In the above example, you’d be obligated to pay the lender $29,460.68 to close out your loan. However, you may be entitled to a partial refund or rebate based on how far along you were in the loan term when you decided to pay it off.
Why Should You Get Your Auto Loan from OnPath FCU?
There are a number of reasons getting your auto loan from a credit union is advantageous, especially if you’re already a member. You’ll generally have a much easier loan approval process since your credit union already knows you and your finances. They’re in the business of providing great customer service and support to members because they want to keep you in the family.
They also offer significantly lower loan minimums than you might find at other auto lending institutions or dealerships. Plus, one of the perks of membership is lower fees on loans, including auto loans.
Federal credit unions also offer low interest rates to members since every member is technically a part owner. When the credit union does well, the benefits get passed on to members.
Contact our team today at 800.749.6193 and learn about the low auto loan rates available to New Orleans residents who bank with OnPath Federal Credit Union.