Paying Off a Car Loan Early in Canada: Good Idea Or Not?

Car loans can be a significant monthly payment. Being in a position to settle a loan early could mean you have more cash to spare each month and one less debt to worry about. Should you always pay off a car loan early? Actually no, as much depends on your situation.

 

You would think that paying off a loan would be a universally positive thing. As usual, things aren’t quite so straightforward.

 

Did you know that paying off a car loan early can cause your credit score to drop? Sounds counter-intuitive but it’s true. That drop is only temporary and it will recover but it happens.

 

Credit scores are about how you manage debt and are not about how sensible you are with your money. Paying off early means you’re managing less debt so your score has less to work with, hence the temporary drop. Successfully balancing multiple debts is how you increase or maintain your score.

 

When Should You Pay Off a Car Loan Early?

There are several situations where paying off your car loan early makes perfect sense. Situations such as:

 

High Interest: If you are paying a higher than usual interest rate, paying it off early could save a significant amount of interest over the term. If you have a significant period to go before the term ends naturally, paying it off early could be a good idea.

 

Bad Credit: The same is true for bad credit car loans. If your credit score has improved and you’re not planning on getting another loan for a while, paying the loan off early could be a good financial move.

 

Improve Debt-to-Income: If you’re looking at getting a mortgage or need to balance your debt, settling a car loan will improve the total amount you owe. This will improve the debt-to-income ratio that is used to calculate affordability for other loans.

 

 

When Shouldn't You Pay Off Your Car Loan Early?

You would think that paying off debts is always a positive move but there are situations where it might not make sense.

 

Cheap Interest Rate: If you are lucky enough to have 0% financing or a low-interest rate, you may be better off leaving the loan to run its course. This is especially true if you could instead pay off more expensive debt such as credit cards.

 

Using Life Savings: Using your life savings or rainy day fund to pay off a car loan could leave you exposed down the line. If paying off the loan leaves you little in the bank to pay for household emergencies or see you through redundancy or other situation, it might not be the best idea.

 

Almost Complete: If you’re close to the end of the term there is very benefit to paying it off early. You could have a few months’ less car payments but it won’t save much in interest.

 

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