Is there a penalty for paying off car loan early?

Paying off a car loan early is what every borrower wants. However, the day you decided this, you would realize that you have to pay a penalty on your early payment. You must be wondering if that is a joke or what? Do penalties for an early payment even exist? You would have various questions and queries. Don’t worry, here we will answer everything you need to know about paying off a car loan early penalty and whether you should consider paying off a car loan early or not.

Before we talk about if it is a good idea to pay off a car loan early or not, let us give you an overview of what are early loan penalties and how to identify them.

What are the early loan payment penalties?

Prepayment loan penalties are charges that the lenders take from the borrower if one pays off their loan early. It is common in mortgages and auto loans. The big idea behind this is to recoup the money that the lender would have received in the form of interest. Lenders lend money to borrowers to make money.

However, if the borrower will pay off the loan early, the major chunk of interest amount that the lender would get would cut off. It is why, when you sign the contract, a clause clearly states about prepayment loans. Moreover, this penalty does not apply to FHA mortgages, student loans, or business loans.

As far as the penalty for an auto loan is concerned, it is allowed in thirty-six states of the US, including the District of Columbia. However, if the loan is for five years or more than that, there is no prepayment penalty. If the loan payment is due between thirty-six months and forty-eight months, then consult with the lender about this clause before you sign the contract.

How to identify a clause for prepayment penalty on an auto loan in the document?

If you live in any state of the US where there is a penalty on paying off your car loan early and if your installments are lesser than sixty months, then keep a thorough eye on the document for car loan prepayment penalty.

There are three ways the lender can include the clause in your document, and you may not know about it. Here we will identify all three of these jumbles of words that are used in the contract. One of the ways used by these lenders is directly stating about prepayment penalty.

Another way is a pre-computed loan. By adding this in a document, the lender ensures that the interest for the entire amount is calculated, and the borrower agrees to pay off the whole amount regardless of how early the payment is made.

Similarly, there is another way that these lenders use, and it is through the full amount of interest. It ensures that you are paying all the extra cash regardless of the dates when you are completing your loan payments. Moreover, in modern times, some lenders also use the “Rule of 78s”. It is similar to a pre-computed loan.

With all of this being said, is it wise to pay off your car loan early? Read further to know more.

Should you pay off your car loan early, and why?

There is no simple answer to this question. The things are not black and white and you’ll have to assess the grey area carefully. Before you decide to pay off your car loan early, you must consider the following pointers.

One of the major reasons you already know. If you are trying to pay off your car loan early, then check your document, if there is a prepayment penalty clause or not. Another vital aspect that you must consider is if you have other debts to pay off that have a higher annual percentage rate. If there are, then paying off those debts would be a wiser decision.

Apart from that, bring your credit score into consideration as well. Although if you decide to close off your credit account on a car loan by paying it off fully, it won’t be bad for the credit score. However, if you chose to stick to monthly payments and pay all of them timely, you may see an increase in your credit score, which may benefit you in the long run.

Last but not the least, consider your monthly budget as well. If you can’t afford your regular expense just because you need to pay off your car loan early, you may end up in a big financial mess.

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