Is it always good to pay off your car loan early, right? There are the obvious benefits:
- more money in your monthly budget,
- improvements to your credit (increased ability to borrow),
- lower insurance opportunities, and
- the general good feelings from not having a loan.
One other area that’s often touted as a benefit is that you are escaping the interest charges on the loan. The general advice is to look at your interest rate, for example 7.5%, and say, “your money could be doing more for you each month if it weren’t tied up in those loan costs of 7.5%.”
But what if you are in your final years of a 5 or 6 year loan? Does the fact that you aren’t paying near as much interest each month in actual cash outlay now make a difference in your decision? Let’s look at this example. Back in July of 2006 you borrowed $15,000 at 7.5% for 5 years to pay for a car. Here are the first and last year amortization schedules:
In the first year of this car loan, you pay over a third of the financing costs.
In the final year, you only pay just $163 to finance this car. So even though you are still paying annual interest of 7.5%, the actual cash outlay is nowhere near what it was in the first two or three years.
Does it make sense then to pay the car off early (at 48 months for example), just to save $163? Am I reading the numbers right? Should this be a factor?
From my experience, paying off a note early had more to do with my cash situation over anything else. If I have enough cash, I don’t want to have debt, regardless of the interest rate. I want the payment out of my life, and I want complete control of the asset. If I’m short on cash or trying to build cash reserves, I’ll hold on to some reasonable debt (i.e. 7.5% car loan).
What about you? Would you hold on to debt, like the car loan in the example above, even if you had the cash?