What Is Better Paying Off Your Car or Trading It In?

A new car can decrease repair costs on your older vehicle.

A new car can decrease repair costs on your older vehicle.

The average American family spends 17.6 percent of the household's income on transportation. Paying off a car loan can drastically reduce this expense. However, advantages may also be realized by trading in a used car for a newer version. Whether or not a consumer should trade in his vehicle will depend on his financial situation and goals.

Advantages of Trade Ins

A trade in for a newer model can provide many benefits, such as the potential to acquire a vehicle that has better gas mileage and requires less repairs. These factors can add up to significant savings. Trading in a vehicle is also much more convenient than having to privately list your vehicle and sell it. This strategy allows you to unload your un-needed vehicle with minimum hassle. Many young people have difficulty saving up enough money for a down payment and a trade-in may allow them to come up with the necessary funds without impacting their pocketbook.

Disadvantages of Trade Ins

Trading in a vehicle typically indicates that you will be purchasing another vehicle on a loan. Just as you are nearing the end of your loan term, you will now be beginning a new loan and acquiring new debt. This situation can negatively impact your credit. If your vehicle is not paid off and you trade it in, the remaining amount of debt will be added to your new loan. This will make your new auto loan exceed the value of your vehicle and may place you in a vulnerable position if you get in an accident. Additionally, you will typically receive less for a trade-in than if you sell your used vehicle to a private buyer.

Advantages of Paying Off Your Car

The most significant benefit of paying off your car is to save the money that you normally pay each month for your car payment. Having the extra cash flow can help you feel less financially burdened and allow you the opportunity to save money. The car loan's interest rate is the amount of money that you are paying for the convenience of financing, so you can basically make a return on your investment that is equal to your current interest rate by paying off the car. You will also decrease the amount of debt you owe and potentially increase your credit score.

Disadvantages of Paying Off Your Car

Paying off your car loan may require you to take a significant amount of money out of savings, leaving you vulnerable if you have an unexpected expense and your savings have dwindled to a low amount. You may also have to pay prepayment penalties because you are depriving the lender of future interest earnings on the loan.

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