Paying off a car loan early feels great, and it can save real money. But it isn’t always the best use of extra cash. Here’s how to decide.
What extra payments do
Car loans use simple interest on the remaining balance. Any extra payment goes straight to principal, which lowers the balance that interest is charged on. The result: less total interest and an earlier payoff date.
The numbers
Take a $25,000 loan at 8% APR over 60 months:
- Regular payment
- $506.91/mo
- Interest with regular payments
- $5,415
- Interest paying $100 extra a month
- $4,325
- Time saved
- 11 mo
- Interest saved
- $1,089
When it makes sense
- Your rate is high. Paying down an 8% or higher loan is a guaranteed return few investments can match safely.
- You already have an emergency fund. Don’t trade your cash cushion for a lower balance.
- You want to free up monthly cash flow before a big life change.
When to wait
- You have higher-interest debt. Credit cards should come first.
- You aren’t getting your full 401(k) match. An employer match is an instant 50% to 100% return.
- Your rate is very low. With a 0% to 3% promotional rate, your money may do better in a high-yield savings account.
- Your lender charges a prepayment penalty. Check your contract first.