Paying off car finance early: how it works and how much you save

The short answer: yes, you can pay off car finance early, and the law says you get back the interest you haven’t used yet. The lender can keep a little extra interest, at most 58 days’ worth on a typical car deal. The earlier you settle, the more you save. On a £20,000 car with £18,000 borrowed over four years at 9.9% APR, settling after a year saves about £1,944. Wait until three years in and the saving shrinks to about £191.

Below is how a settlement figure is worked out, what you’d save at each point in a deal, the difference between Hire Purchase and PCP, and when it’s better to leave your money where it is.

Your right to settle early

If your finance is a regulated consumer credit agreement, and almost all personal car finance is, the Consumer Credit Act 1974 gives you two rights that matter here:

• The right to pay off early, in full or in part (section 94). You can do it at any time before the last payment. You don’t need the lender’s permission and you don’t need a reason.
• The right to a settlement figure (section 97). Ask in writing and the lender has to send you a statement of what you owe, free, within 7 working days.

How much you pay is set by the Consumer Credit (Early Settlement) Regulations 2004. They say the lender must take off a rebate for the interest you won’t now be charged. This applies to Hire Purchase, PCP, conditional sale and personal car loans alike.

One thing catches people out: the rules treat the settlement date as 28 days after the lender gets your request. If the deal was longer than 12 months, the lender can push it back another 30 days. So you pay interest for up to 58 days beyond the day you asked. That isn’t a penalty fee. It’s the only extra the law allows, and lenders state it on the quote. The Financial Ombudsman regularly rejects complaints about it when the lender has followed the rules.

What a settlement figure is made of

Think of it in three parts:

1. The balance you still owe, worked out at your APR. Early on, most of each payment goes on interest, so the balance falls slowly at first and faster towards the end.
2. Up to 58 days of extra interest on that balance, or 28 days on a deal of 12 months or less.
3. On PCP, the balloon payment as well, because you’re buying the car outright rather than handing it back.

Whatever you’d have paid after that point, less the settlement figure, is your saving.

How much you save at each stage

Here’s the same £20,000 car with a £2,000 deposit over 48 months at 9.9% APR. On Hire Purchase the payment is £452.02 a month. On PCP it’s £314.30 with an £8,000 balloon at the end. The figures are estimates using the 58-day rule.

Two things stand out. First, the saving falls quickly. Halfway through the Hire Purchase deal you’d save about £853, and in the last year it’s barely worth the paperwork. Second, PCP saves more at every stage. The £8,000 balloon gathers interest for the whole term, so clearing it early cuts more interest. If you’re on PCP, plan to keep the car and have the money, settling early is one of the better uses of savings.

Your lender’s figure will be a little different. Lenders count days, not months, and some charge an option-to-purchase fee of £10 to £200 on the last payment. The pattern is the same, though, and this table is a fair way to check whether a quote looks right.

How to settle, step by step

1. Find your agreement. Check the APR, the term and whether it’s regulated. The front page will say “regulated by the Consumer Credit Act 1974”.
2. Ask the finance company for a settlement figure. Not the dealer: the lender is usually a separate company such as a bank or the carmaker’s finance arm. Most big lenders show it in an online account. In writing, they have 7 working days.
3. Check the date it’s valid until. Usually 28 days. Any payment that falls due before then normally still comes out, and the figure assumes it does.
4. Pay by bank transfer to the lender’s settlement account. Use the reference they give you.
5. Get written confirmation. Keep the letter saying the agreement is settled and the car is yours. Check your credit file a month or two later to make sure it shows as settled.

Paying off part of it instead

Section 94 also lets you pay off part of the balance early. Say you get a £3,000 bonus a year into the Hire Purchase deal above. You have two choices:

• Keep the payment and shorten the deal. The remaining 36 months drop to about 28, and you pay roughly £860 less interest.
• Keep the term and lower the payment. The monthly payment falls from £452.02 to about £356.

Shortening the term saves more interest. Lowering the payment helps if money is tight. The lender may still keep up to 58 days’ interest on the part you pay off, which here is about £45. The loan overpayment calculator shows both options for your own figures.

When settling early is worth it, and when it isn’t

The simple test is to compare rates. Money in an easy access account might earn 3% to 4.5% before tax. Car finance at 9.9% APR costs you more than that, so clearing it is like getting a guaranteed 9.9% return. On a 0% APR deal there’s no interest to save, so keep the cash and let it earn.

If the car is on PCP and you expect to hand it back at the end, think twice. Settling means paying the balloon, so you’d be buying a car you planned to return. You might do better selling or part-exchanging it if it’s worth more than the balloon, or using voluntary termination if you’ve paid half.

Selling or part-exchanging a car with finance on it

On Hire Purchase and PCP the finance company owns the car until the last payment. That has real consequences:

• Part-exchange is easy. The dealer gets the settlement figure, pays it and takes it off what they offer you. If the car is worth more than the settlement, the difference goes towards your next car.
• Selling privately means settling first. You can’t legally sell a car you don’t own. Private buyers are protected by the Hire Purchase Act 1964 if they buy in good faith, but the lender can still pursue you for the money.
• Buyers will check. A vehicle history check shows outstanding finance, so expect a buyer to ask for proof it’s been cleared.

A personal loan is different. The car is yours from day one, so you can sell it whenever you like. You just keep repaying the loan, or clear it with the sale money.

Common mistakes

• Asking the dealer for a settlement figure. They often can’t give an accurate one. Go to the lender.
• Letting the quote run out. Settlement figures are usually valid for 28 days, and a new one will be a bit different.
• Forgetting the balloon on PCP. The settlement figure includes it, so it’s far bigger than the monthly payments might suggest.
• Paying off a 0% deal while holding savings that earn interest. You lose the interest and gain nothing.
• Clearing car finance before dearer debt. Credit cards and overdrafts at 20% or more come first.

Next step

Put your deal into the car finance calculator to see the total you’d pay if you let it run, then ask your lender for a settlement figure and compare. If you’re weighing up a lump sum or extra monthly payments, the loan overpayment calculator shows how much each option saves. Still choosing finance for your next car? Our guide to PCP vs HP compares the two types on the same car.

This is general information, not financial advice. Settlement figures here are estimates; your lender’s figure is the one that counts.