Everyone wants to be debt free, but sometimes paying off a loan early can make managing finances elsewhere a bit more complicated. Just because you can do something doesn't mean you should do it. Let's examine the benefits and potential drawbacks of early repayment and the option to refinance car loan agreements.

How does a 72-month car loan work?

A 72-month car loan is no different than any other installment loan. The borrower signs a contract to pay a specific amount each month until the loan balance is paid off. That payment includes a percentage that goes to the principal, a percentage that goes to interest, and any additional monthly fees. The payment and the interest rate are typically fixed.

The percentages of each payment are outlined on an amortization schedule that is given to the borrower as part of their original loan agreement. That agreement also includes the terms and conditions of the loan, one of which might be a penalty for early repayment. This is important to look for if you consider paying off your loan early.

This is where the situation can get complicated. Amortization typically has most of the early payments in a loan agreement going towards interest, so an early repayment might not save you that much if you're past the 36-month mark. Add in the early repayment fee, if there is one, and it might be more cost-effective to keep making monthly payments on your current car loan.

Refinancing to Pay Off a Car Loan Early

Paying off a 72-month car loan early can be done with a lump sum cash payment or by refinancing with a new loan. If there is one, this doesn't eliminate the early repayment penalty, but it will spread out the financial obligation over several months or years. This is often done to secure a better interest rate or lower the monthly payment obligation.

In some cases, car owners opt to use consolidation loans to pay off the balance on their car loan. They add it to the outstanding balance on their credit cards and then take out a loan for the entire amount, essentially eliminating all debt except the new loan. In some cases, debt consolidation can free up hundreds of dollars in debt payments if done correctly.

When is the right time to pay off a car loan early?

The best time to pay off a 72-month car loan early is within the first two years (24 months) of the agreement to avoid paying extra interest. After the 36-month mark, most of your monthly car payment is going to principle, so the savings aren't as substantial. Paying the loan off in year six is essentially a bookkeeping action. Savings will be minimal or non-existent.

Another good time to pay off a car loan is right before you buy a house. The bank may even require it before they'll approve you for a mortgage. In a scenario like that, the early repayment penalty is worth absorbing because a lower debt-to-income ratio could score you a lower interest rate on the mortgage. That savings will more than cover the extra cost.

The Bottom Line

Paying off your car loan early has its pros and cons. It all depends on when you decide to pay it off and how you go about doing so. You can pay your car loan with a lump sum or refinance your loan to potentially lower your monthly payments and pay less interest. As always, it's best to complete your research to find out what will work best for your financial situation.

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