Most people who purchase a new (or otherwise expensive) vehicle find that they have to finance some or all of the tab with a loan. And whenever you enter into a situation where you’re borrowing money from a bank, the catch is that you’ll have to pay it back with interest, generally at a higher rate than whatever the bank could be earning on that money in the meantime. The upside is instant access to cash; the downside is the additional interest you’ll accrue, and depending on the size and duration of your loan this number could end up being rather sizable. So what if you should happen to come into some money after you’ve already taken out a loan? Should you pay it off early? Here are some of the things you’ll want to consider before you decide.
The first is your credit score. Many people are worried that paying off a loan early could damage their credit score because of the interest payments they’ll miss out on. In truth, this sort of depends on your current credit rating. If your credit is already top tier you stand to lose nothing by paying your car loan early. The only reason to continue paying interest on a loan is to raise your credit score by showing that you can manage debt in a responsible manner. In essence you are buying up your credit rating. So it all depends on your goals. Would you rather continue to improve your credit and have money in the bank or get the debt off your books? The answer to this question will determine if you want to pay early based on the potential benefits to your credit.
Of course, you should also think about the interest you could be earning on your money over time if it wasn’t going to your loan. Now, you might think that you would be better off investing the chunk of money you currently have in your savings account since it’s possible that you could earn more interest on it than you’re spending on your loan. This is possible, but not probable. You will almost always pay more than you can earn when it comes to interest, so you’re likely better off paying the loan now and keeping the money you would have paid in interest. Even a low, low rate on a car loan will come out around 3-5% (and rates are incredibly low right now). Just for comparison, a savings account will earn you about 1% and a CD will net you a whopping 1-2% these days (even for a five-year option).
Although some types of investment (stocks and bonds, for example) could show a higher return than average, they also tend to come with greater risk of loss. No risk, no reward. But if your ultimate goal is to get the most from your money, odds are you’ll keep more money in your pocket by paying your loan off as soon as possible. And considering that you could still put the money that would have gone to monthly car payments into investments (if you don’t need it for car, truck, or static caravan insurance), you stand to save more AND earn more by paying your loan now. You can take that to the bank.