Should I Pay Off My Car Loan Early?

by on August 11, 2011

So you’ve saved some money and are trying to reduce your monthly expenses to get your household budget in order.  Should you pay off your car loan early?  Let’s go over the pros and cons of paying your car loan early.

First of all, find out what interest rate you’re paying on your loan and compare that to the opportunity cost of investing that money elsewhere.  Look at the expected rate you would earn on that money if you invested it.  If you would put it into a savings account and only earn a percent or less, then you would be doing better by paying off the car loan, assuming its a higher rate than your savings rate.  If you would invest the money that you are planning to pay off the car loan with in stocks, your expected return would be in the range of 5-15%.  Compare this to your car loan and see which is higher.  Basically, the higher the loan rate on your car, the more sense it makes to pay down your loan early.

Another important factor in your consideration is your monthly budget situation.  If you are running about breakeven on your budget, as in you are spending about what you earn, then paying off your car loan will eliminate your car payment and put you into the black on your monthly budget.  You can then use that extra money to save each month.  For some, this gives enough peace of mind that it is worth it to pay off the debt early.  It also eliminates one more creditor!should i pay off my car early

The next factor to look at before making your decision is your other debt situation.  Most people have many different debts, including credit cards, car loans, mortgages and student loans.  Before you pay off your car loan, make sure that you pay off any higher interest rate debt first.  Because your mortgage and student loans are tax deductible, it probably doesn’t make sense to pay them off first, even if they are a slightly higher interest rate.  However, if you have any credit card or unsecured debt, you should pay that off first, even if it’s at a lower rate (because credit card terms can change at any time).

So you’re almost ready to make your decision, there are just two more things to take into account.  Your savings situation and your comfort level.  Before paying off your car loan you should make sure that you have enough money saved to cover any unemployment or unforeseen circumstances.  There is no magic amount of savings needed, but most advisors recommend between 3-6 months of savings, with this amount being increased as you get older.

Finally, gauge your comfort level.  In other words, how good does it make you feel to get rid of your car payment and another creditor?  Do you sometimes worry about having that car loan?  If you are still on the fence as to pay off your car loan or not, use this as the deciding factor.  Just remember, you can’t get the money back after paying off your loan if you should need it for something else.  Good luck with your decision!

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