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Ask Dr. Don
Bankrate.com

Auto loan interest deductions?

Dear Dr. Don,
Is the interest paid on an automobile loan tax-deductible? Also, how do I find out about prepayment penalties on said loan?
L.S. Model

Dear L.S.
Interest paid on consumer debt other than mortgage debt hasn't been deductible since the Tax Reform Act of 1986. That's why some consumers use home equity lines of credit or home equity loans to finance car purchases. It's also a reason why automakers' zero-percent loan promotions are so popular with consumers.

If your loan has a prepayment penalty, that penalty will be spelled out in the loan documents. If you can't find your loan documents or you can't find anything in the paperwork that speaks to a prepayment penalty, then call the lender and ask them.

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Sometimes the interest expense on auto loans is computed using the Rule of 78s. This approach front-loads the interest expense, so paying off your loan early results in an implied prepayment penalty. This approach isn't used very often anymore except by lenders in the subprime market.

This Bankrate feature explains the Rule of 78s and its de facto prepayment penalty. Again, if your loan document doesn't address how interest is computed you can discuss this issue with your lender.

-- Posted: Sept. 23, 2002

Read more Dr. Don columns
See Also
Rule of 78: Watch out for this auto loan trick
Making prepayments on an auto loan
Financial advice glossary
More Dr. Don stories

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