Dubai: It’s not uncommon to owe more on a car than its worth after the loan has been paid off. But even though logic dictates that a loan be paid down as early as one can, it is not always advantageous to.
“Paying off a car loan early can be a great idea, but it might not always make sense to, as often times there are better ways to spend or save any extra money,” explained Dubai-based wealth advisor Mohammad Shaan.
One way to go about it is to pay the remaining balance of the loan at one time in one lump-sum payment.
When making use of this option, you can find out the remaining cost of your loan as well as any additional fees that may come with paying early by contacting your lender.
What else can I do if I can’t pay it off in one go?
It’s not often anybody can come up enough money to pay off his or her debts in one go – unless the amount isn’t significantly high. Here are your other options that UAE experts recommend:
• Pay a little extra each month
“If you can’t pay it off in one go, another way is to pay a little bit extra every month by rounding up the payments to a higher number, say to the nearest Dh100,” Shaan added.
For example, if your car payment is currently Dh275 per month, you can round it up to Dh300 and pay an extra Dh25 per month.
“This can take longer than making one lump sum, but it could be a good choice if you only have a bit of extra income a month to spare for paying off the car loan,” Shaan further explained.
• Make a payment every two weeks
If the option is made available to you, experts recommend submitting payments every two weeks on your vehicle instead of monthly can also help you pay off the loan a little earlier.
“By paying half of your monthly payment every two weeks, you end up making a total of 26 payments per year, which is equivalent to making 13 monthly payments in one year rather than 12,” suggested Abu Dhabi-based independent debt consultant Rajesh Markara.
“Contact your lender to make sure this is an option and for their assistance in setting it up.”
Are there downsides to paying off your car loan early?
Some lenders charge a penalty for paying off a car loan early. The lender makes money from the interest you pay on your loan each month.
Repaying a loan early usually means you won’t pay any more interest, but there could be an early prepayment fee. The cost of those fees may be more than the interest you’ll pay over the rest of the loan.
“If that’s the case, it makes more sense to keep making your regular monthly payments instead of paying the loan off early. Check your financing documents or talk to your lender to see if there are prepayment penalties,” Markara added.
“You may not want to pay off your car loan early if it’s going to put you in a precarious financial situation. Depleting your savings or making larger monthly payments than you can afford may help you pay off this particular debt faster, but it could make it difficult to cover surprise expenses later.”
Debt experts also suggest that you should only pursue paying off your car loan early if it doesn’t add unnecessary stress to your finances.
Avoid being “upside-down” on your car loan: Here’s how
It’s not uncommon for someone to owe more on a car than it’s worth. This is what’s experts refer to as being ‘upside-down’ on a car loan.
“Being upside-down on your loan is a potentially risky situation,” Shaan explained.
“If you were in an accident and totaled the car while you're ‘upside down’ on your loan, you’d have to pay back the lender the worth of the vehicle plus the negative equity. Paying off your car loan early could help mitigate this risk.”
Similarly, a debt-to-income ratio is the amount of money you make in a given period compared to the amount you owe in debt.
“Lowering this ratio may improve your credit, help you get approved for other loans (like a home mortgage), and help you qualify for lower interest rates,” Shaan added.
What to be the most mindful of when paying off your car loan?
If you’re wondering whether you should pay off your car loan early, you may have several reasons to do so. The most obvious reason you might want to consider paying off a loan early is that it saves you money on the amount of interest you pay.
However, Markara added that it’s important to note that this only applies if you are paying a simple and not precomputed interest rate.
“A simple interest rate is calculated monthly based on what you still owe, meaning if you pay off your loan earlier, you won’t have to pay the interest that would have accrued over the remainder of your loan,” he explained.
“A precomputed rate, on the other hand, is determined at the beginning of your contract and remains a fixed amount for the entirety of your loan, so it’s likely you’d still be on the hook for that amount whether you paid the loan off early or not.”
Paying off your car loan early also means that you could potentially free up money in your monthly budget, meaning you have more room to spend on other debts or necessities. You could even save the extra cash for a rainy day.
Paying off the loan early gives you full ownership of your vehicle, which can come in handy if you need to sell it quickly. If you have high-interest debt, you may want to pay that off before you pay off your car or invest. If your car loan has a high interest rate, it would make sense to pay it off before you invest.
Find a way to do both? Rules of thumb are guidelines, and there will always be exceptions. If you're dealing with extremely high-interest debt, focus on that first, but after strive to make monthly progress on both retirement and paying off debt.
