For many people, the thought of being debt-free sooner is a big motivator. When it comes to your car finance, settling the agreement early could save you money and give you full ownership of your vehicle. But is it always the right choice? It’s a question that depends heavily on your specific financial situation and the type of finance agreement you have. In this guide, we’ll break down the pros and cons and look at the specifics for Hire Purchase, Personal Contract Purchase, and Personal Loans.
What Does Paying Car Finance Early Mean?
Paying off car finance early means you are repaying the remaining balance of your car loan in a single lump sum, instead of continuing with the scheduled monthly payments. When you do this, you contact your lender and request a “settlement figure,” which is the total amount you need to pay to close the loan. It may also be referred to as ‘settling car finance’ or ‘early termination‘.
What are the Benefits?
- Save on Interest: The most significant benefit of paying off car finance early is the money you can save. By paying off the loan ahead of schedule, you reduce the total amount of interest you’ll pay over the term of the agreement.
- Gain Full Ownership: Once the finance is settled, the car is legally yours. This gives you the freedom to sell the car, modify it, or use it as an asset without any restrictions from the lender.
- Improve Your Debt-to-Income Ratio: Clearing a car loan can positively impact your credit score by reducing your overall debt. This can be beneficial if you’re planning to apply for other forms of credit, such as a mortgage, in the near future.
- Peace of Mind: Knowing you are free from a monthly car payment can be a huge relief and frees up cash flow for other financial goals.
Are There Any Disadvantages Of Paying Off Car Finance?
- Early Repayment Charges: When you settle car finance early, many lenders include a clause in the contract that charges a penalty for early repayment. While UK law caps these fees, they can still reduce the amount you save on interest. You’ll need to calculate whether the savings outweigh this fee.
- Negative Equity: If your car has depreciated in value faster than you’ve been paying off the loan, you could be in a position of ‘negative equity’ (the car is worth less than the outstanding finance). In this case, paying car finance off early to sell the car would mean you have to pay the difference out of your own pocket.
- Opportunity Cost: The lump sum of money you use to pay off the car could potentially be better used elsewhere, especially if your car loan has a low interest rate. For example, you might get a better return by putting that money into an investment or using it to pay off higher-interest debts, like credit cards.
- Impact on Credit Score: While paying off a debt is generally good for your credit, closing an account can sometimes cause a temporary, short-term dip in your credit score.
Whether settling your car finance early is right for your situation can depend on which type of car finance agreement you have. The most popular ways to finance a car are through Hire Purchase, PCP and Personal Loans. Each car finance agreement has its own structure and can vary on factors like car ownership, term length, and early termination fees.
Hire Purchase.
With an HP agreement, you don’t own the car until the final payment is made. If you pay off your Hire Purchase early, you’ll save on the remaining interest and become the legal owner of the vehicle sooner. There may be a small ‘Option to Purchase’ fee, but you will not have to worry about a large balloon payment at the end. You can also terminate the agreement and hand the car back without any further payments if you have already paid off 50% or more of the total amount.
Personal Contract Purchase.
PCP agreements are different because your monthly payments cover the depreciation of the car, not its full value. If you want to settle a PCP agreement early and keep the car, you must pay the remaining balance plus the large optional ‘balloon payment‘ that was deferred to the end of the term. You will also have to pay any early repayment charges. This can be a substantial sum, but it does allow you to gain full ownership of the vehicle and the flexibility to sell it on. Similar to HP, you have the legal right to voluntarily terminate the contract and hand the car back if you have paid at least 50% of the total amount payable (including the balloon payment).
Personal Loans.
When you finance a car with a personal loan, you own the car from day one, as the loan is unsecured. If you pay off the loan early, you will be subject to any early repayment charges specified by the lender. You will save on the remaining interest, and since you already own the car, you can sell it at any time without having to settle the finance first.
When Does Paying Off Car Finance Early Make Sense?
Paying off your car finance early makes the most sense when it is financially beneficial and aligns with your personal goals. It is most cost-effective when the total amount of interest you will save is greater than any early repayment charges. This is often the case if you have a high-interest rate and a significant portion of your term remaining. It also makes sense if you have a lump sum of money available that you wouldn’t otherwise use for a higher-interest debt or investment. Ultimately, if you’re in a position of positive equity (the car is worth more than the remaining finance) and want the freedom of full ownership, early repayment could be a smart and satisfying financial decision.