If you’re trying to decide between two lenders offering a comparable interest rate, the one that doesn’t charge a prepayment penalty has a clear edge. That said, some online lenders don’t charge this fee at all. So if you pay back an outstanding balance of $3,000 with a lump sum payment, your lender may tack on a $60 fee to recoup a small percentage of their lost income. But thankfully, the average charge these days is just 2% of your loan’s remaining balance, according to Experian. In the olden days, lenders would charge you that full $1,000 to get their due. Nice!īut your lender will be like ummm interest is our income - we’re glad you paid us back what you borrowed, but you’re also kinda stiffing us out of $1,000. Now, if you get a new job and pay off your loan in full in just 18 months, you may save yourself around $1,350 in interest. It may sound baffling or spiteful, but it’s actually just simple economics.Īs illustrated by our auto loan calculator, if you take out a $35,000 loan at 5% interest for 36 months, you’ll end up paying about $2,750 in total interest. What Is a Prepayment Penalty?Ī prepayment penalty is a fee that a lender charges you for paying back your loan before the end of your scheduled loan term (your designated time period for repayment). That said, they may charge you a fee, called a prepayment penalty. After all, any amount of outstanding debt is a risk for them. Generally speaking, lenders won’t stop you from paying them back early. What Happens When You Pay Off a Car Loan Early? Check your loan documents or just give them a call to find out what their process looks like. Most lenders will have a checkbox somewhere to indicate that you’d like extra payments to apply to your principal. So, if you pay $1,000 instead of $500 next month, where does the extra $500 go? Principal or interest?Įvery lender is different, but many will simply see the extra money and go “gee, thanks!” and apply more of it to interest (i.e., pay themselves).īut you’re allowed (and encouraged) to tell your lender “hey, please apply this to my principal so I can pay off my loan faster.” If I Pay Extra on My Car Loan Does It Go to Principal?Īuto loans are amortized, meaning some of your monthly payment goes to your principal and some goes to interest. Most of the time, though, you’ll be on a simple interest plan - so that’ll be our focus moving forward. For that reason, if you ever consider this type of loan agreement, you’ll definitely want to ensure that your lender offers an early repayment refund. With precomputed interest, lenders tend to be less concerned with how quickly you pay off your loan since they’re getting the same amount of interest either way. Whether you’re paying simple or precomputed interest will make a difference in your options for early payment.įor simple interest, some lenders will charge you a fee for paying off your loan early since they’ll be missing out on some expected interest aka income. Precomputed interest is all calculated upfront, and the total amount of interest you have to pay your lender doesn’t change even if you start paying off your car loan faster. If you start making payments earlier, more frequently, or simply pay more than your monthly payment, your remaining interest should shrink in real-time, allowing you to pay off your car loan early. Simple interest, which the vast majority of lenders use, is calculated using your outstanding balance on the day your payment is due. In your existing and future loan documents, you may also run into two different types of interest: Interest equals income for lenders keep that in mind as we dive further in. Interest is the “fee” charged by the lender for borrowing money. So if you’re buying a $30,000 car and can make a down payment of $5,000, you’ll be borrowing the other $25,000. Principal is the total amount of money you’re borrowing to buy the car. Before we discuss the pros and cons of paying off your car loan early, let’s do a refresher on how auto loan payments work in the first place.
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