A car is a large purchase, and many people – especially those purchasing their first car – choose to finance the transaction through an auto loan. When you finance a car, you free up money in the short term but end up making monthly payments for a set period, usually three to five years. That said, you can always pay off your car in full earlier than necessary. Doing so has a number of advantages.
Saving on Interest
Unless you were able to get a special zero-percent down auto loan, paying your car loan off in full will save you money in interest payments. Each month, a portion of your car payment goes toward the principal loan amount -- the money that actually paid for your car -- and another portion pays the interest on the loan. The advantage of paying off your car loan in full is that you’ll avoid paying the interest that will have continued to accumulate.
Increasing Your Creditworthiness
Usually, paying off a loan will improve your credit score. Credit is very important when you want to get a loan, purchase a house or apply for a credit card. Some employers may even check your credit report to determine how responsible you are. By paying off your loan, you're decreasing your overall debt and showing that you responsibly settle your financial commitments. Of course, having no loans or credit accounts can prevent you from building credit, so try to keep some accounts open and current.
Improving Your Cash Flow
If you’ve ever had an auto loan, you know what it’s like to budget every month for your car payment. By paying your car loan in full, you might take a chunk of money out of your savings, but you’ll also free up some funds every month. This can help you replenish your savings or enable you to do things you may not otherwise do, such as travel, take classes or make another large purchase.
Decreasing Your Insurance Obligation
State laws require you to have certain amounts of auto insurance for liability purposes, meaning that the insurance company will pay for damages or injuries you cause in an auto accident. Your lender also requires you to have another type of insurance coverage called comprehensive -- or full coverage -- which pays for damages to the car that are your fault or caused by things like vandalism or weather. When you pay off your auto loan, you can opt out of comprehensive coverage, which could save you some money each month. Of course, you’ll also need to pay for your comprehensive damages out of pocket if you do this.
- Digital Vision./Photodisc/Getty Images