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Should I Pay Off My Car Loan Early in Canada? 5 Minute Guide

Should I Pay Off My Car Loan Early in Canada? 5 Minute Guide

At face value, paying off any debt is a good idea. Yet there are pros and cons to paying off a car loan early and that’s what we’re discussing today. Whether it’s a good idea to pay off a loan early or not.


Before you get into whether you should pay off a loan early, you should first see if you can.

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Paying Off Car Loans Early

Not all lenders and not all car loans can be settled early. Some have early repayment penalties and others don’t want you overpaying at all. Check your loan paperwork to see whether yours is one of them.


There’s no point continuing with this if you’re going to be paying a fee or cannot settle early!


The Benefits of Paying Off a Car Loan Early

There are definite benefits to settling your car loan ahead of time. They include:


  • Less Per Month: While car loans tend to be affordable, it’s one more outgoing. Paying it off means more money in your pocket at the end of each month.


  • Upgrade Your Vehicle: Once you settle one car loan, you are free to get another. While that may not be your intention, it’s a definite benefit of settling. Buy a faster, more luxurious or larger car or whatever you need.


  • Lower Debt-to-Income Ratio: If you’re close to 30% of your debt-to-income ratio, paying off your loan early can rebalance that.


Debt-to-income ratio. Source: https://www.mortgagecalculator.org/calcs/debt-ratio.php


Save on Interest: You pay interest over the term of your car loan so paying it off early means paying less interest. This can be especially valuable if you’re on a higher rate than usual.


The Downsides of Paying off a Car Loan Early

There are also downsides to paying off a car loan ahead of time. They include:


Stops Improving Credit Score: Successfully managing a car loan helps create a positive payment history and contributes to your credit score. It also widens your credit mix and credit account age which also has a minor impact on your credit score.


How credit score is calculated

How credit score is calculated. Source: https://www.canadadrives.ca/blog/car-finance/5-factors-that-impact-your-credit-score-in-canada


Higher Interest Debt Takes Priority: If you have other, more expensive debt, it makes sense to pay that off first. Even if it’s for a lower amount per month, if you’re paying more interest on it, that should be paid before your car loan.


Early Repayment Penalties

Some loans come with early repayment penalties. These are designed to ensure the lender makes a profit even if you pay off the loan early. Think of it as compensation for the lender for not earning the full interest.


When you’re trying to put extra money towards a loan you’re going to run into problems with one of 2 policies. Either they lender will simply not allow you to add money to the loan payment because it’s against the policy, or they’ll put that extra money into the system as an “early payment” which means that instead of contributing to the loan now, it counts that payment as next months payment that you just happen to have kindly put up now. 


That money will hang in cyberspace for a month until the payment is processed on your next scheduled loan payment, and you simply won’t be charged for that month, because you’ve already paid it.


Principal Payment vs Regular Payment

If you can get past that part, another barrier you’re going to hit is what part of the loan the money actually goes towards. The principal amount, which is the money that was actually lent to you, or the interest, which is added to the loan at a monthly rate based on a percentage of the remaining principal amount. 


Generally loan payments are skewed so that most of the payment goes towards the interest, and only some of it goes towards the principal amount, obviously because paying the principal means the loan is shorter and you get charged less interest. Many lenders simply won’t allow you to specify a principal-only payment. 


Pre-Calculated Interest

If you have a pre-calculated, or precomputed interest loan then you may find it almost impossible to actually repay the loan early. A pre-calculated interest loan is exactly what it sounds like, a loan where the amount of interest that you’re going to pay has been calculated ahead of time and factored into the loan repayment plan.


If you try to repay the loan early then you’ll end up saving no money because you’re still contractually obligated to pay the pre-calculated interest meaning that you won’t even save any money by paying the loan early, so it’s probably not worth doing. 


A better plan may be to take the extra money you were going to spend to pay off the loan, and tuck it away in a savings account instead. That way it can at least start working for you in another way. 


Using up savings – If you’re using up all your savings to pay off the loan, will it leave you exposed in the event of an emergency? Will you still have an emergency pot for if something happens?


Tips to Pay Off a Car Loan Early

Round up Your Monthly Payments

Rounding up your monthly loan payments is a very effective way to overpay your auto loan. You can overpay by a little or by a lot, depending on your situation.


For example, your current auto loan payment is $314 per month. You could round up to $400 per month and overpay by $86. Or you could round up further to $450-500 depending on your situation.


Bi-Weekly Payments

The majority of Smithville auto loans are paid monthly, which works for the majority of situations. However, you can elect to pay fortnightly if you want to.


If you’re paid fortnightly, this can have a real benefit. Plus, paying your loan amount in two stages can actually lower the interest due overall. It’s a modest improvement but you will be able to pay the loan off faster this way.


Lump Sum Overpayments

You can also make lump sum overpayments on an auto loan. This uses a few hundred or few thousand dollars to pay down the principal amount, lowering the overall loan.


If you get a bonus from work, share dividend, sell something valuable or get income from elsewhere, you can use it to pay off a chunk of your loan.


How to Overpay an Auto Loan in Ontario

You can overpay your auto loan by contacting the lender. Monthly overpayments can be made by asking them to take an agreed amount per month along with the minimum payment.


The same for fortnightly payments. Agree with the lender and go from there.


Lump sum overpayments can be made as and when you have the money to make them. Contact the lender and tell them what you want to do. They will let you know how to make the payment.


In all cases, make it clear to the lender that you’re overpaying the principal and not the whole amount!


We will use all our skills and experience to deliver the lowest possible Beamsville car loan rates, guaranteed. Contact Car Nation Canada Direct to learn how we can help.


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