Use these four questions to help you decide.

Paying off a car loan early eliminates a monthly payment, but is it the best financial move? It depends on several factors, including your emergency fund, plans for other borrowing and any potential prepayment penalties. Use these questions to decide if prepaying your car loan is the right move for you.

How prepared are you for unexpected expenses?

Having a car paid off can bring a real sense of satisfaction but if your emergency fund is low or nonexistent, paying off a car loan early might not be the best use of your cash.

Let’s look at a hypothetical situation. Kayla has $5,000 left to pay on her car loan and no money saved for emergencies. With a tax refund and a modest inheritance, however, she has enough money to pay off the loan in full. If she then needs to cover an unexpected car repair or veterinary bill, she’ll have to put the expense on a credit card, which charges a higher interest rate than her auto loan.

If you have savings to cover three to six months of essential expenses, paying off an auto loan early can be a smart financial move.

Are you applying for another loan, such as a mortgage?

Paying off a car loan early can be advantageous if you’re planning to buy a home soon. When you apply for a mortgage, your lender will look at your debt-to-income ratio. The less debt you have, the lower your ratio and the more likely you’ll be approved for a home loan.

Early repayment may also cause a temporary dip in your credit score. The credit reporting agency Experian says a dip can occur if the auto loan was the only open installment loan you had but, “Your score should rebound in few months if there are no negative items in your credit report.”

Is there a prepayment penalty?

Some auto loan contracts charge a penalty if the loan is paid off early. Typically, this fee is 1% to 2% percent of the remaining balance. On a $10,000 balance, a 2% fee means paying a $200 penalty. To determine whether it’s worth paying the fee, compare it with the amount of interest you’d pay on the remainder of the loan. If the fee is less than the total interest charges, paying the loan can save you money.

Do you want to minimize insurance costs?

When you get an auto loan, the lender typically requires you to carry full comprehensive and collision coverage. If you pay off the loan early, you can adjust the coverage limits and reduce your insurance premium.

Keep in mind, if you lower the coverage limits and later have a claim for theft or damage, you’ll be responsible for more of the repair or replacement costs out of pocket.

Paying off a car loan early can free up money for other financial goals if it fits your overall financial plan. Before paying off your loan, consider your emergency savings, future borrowing needs, prepayment penalties and insurance costs.

 

All loans subject to approval. Rates, terms, and conditions are subject to change may vary based on credit worthiness, qualifications, and collateral conditions.