If you pay your loan off early, you may pay less interest. But some lenders also charge prepayment penalties. This will depend on your specific lender.
Borrowing money is not free. There is always some price that you pay to borrow some cash from a lender, no matter what the loan is for. The only exception is when you are able to borrow money from a friend or family member at zero interest. But only about 10% of Americans can borrow money from friends and family.1 Lenders make money by charging borrowers interest on the loan balance.
Financial advisors often encourage borrowers to pay off their personal loans and auto loans early to save on interest. In many circumstances, this is an excellent idea for minimizing the out-of-pocket costs associated with taking out a loan. However, it is not possible in all instances, so it is important to research the lender and the loan you are considering beforehand.
Can You Pay off a Personal Loan Early?
Depending on your lender, you may be able to pay off your personal loan early. The exception is when a lender charges a prepayment penalty fee for early repayment of installment loans.
If your lender doesn’t charge a prepayment penalty, then you can pay off debt faster to save money. Every little bit of extra cash you pay on your loan over the monthly payment will save money on the total amount you will have to pay in interest.
Why Pay Off Your Personal Loan Early?
There are several excellent reasons why it might be wise to pay off a personal loan early. Here are a few of the benefits you could receive:
Save On Interest
When you pay off a personal loan early, you can save a considerable amount of money on interest payments. Whether it is an auto loan or a personal loan, each month the interest rate is applied to your balance which causes it to grow. If you are able to pay off your loan early, that will mean there are several months worth of charges you will never have to pay because the balance the interest rate is applied to will be zero.
Open Up Your Monthly Budget
Loan payments have a tendency to take over our budget. Your personal or auto loan could be eating up a considerable portion of your income every month, making it difficult to put your money towards what you actually want. When you pay off a personal loan early, you could free up your budget to save up for a trip to Europe or build up your savings.
Improve Your Debt-to-Income Ratio
Your debt-to-income (DTI) ratio compares how much money you bring in every month to your debt obligations. Your debt-to-income ratio can determine your overall financial health because having a ratio too high can mean you are living paycheck to paycheck with a problematic amount of debt.
Additionally, potential lenders will look at your debt-to-income ratio on your credit report when determining loan approval. Minimizing your debt by paying off your personal or car loan early can improve your chances of accessing the financial opportunities you want.
Avoid Going Upside Down on Your Car Loan
There is a unique risk that comes with paying off a car because of how quickly they depreciate in value. It’s often said that the minute you purchase a car and drive off the lot, its value plummets. If you pay off a car too slowly, you risk owing more on your car than it is worth. When this happens, you end up with an upside down loan.
Upside down loans can become a major issue if your car becomes totaled in an accident because the insurance pay out might be less than what you own on the car loan. Paying off your car loan early could significantly reduce that risk.
Possible Drawbacks To Be Aware of When Paying Off Your Loan Early
While there are many potential benefits to paying off your loan early, there are also drawbacks. For example, a lender may charge a prepayment penalty fee if you repay the personal loan early. Paying the prepayment penalty fee might be worth it if you can save a lot more on interest. But in most cases, a prepayment penalty fee is not worth paying. A prepayment penalty fee is typically a flat fee, but some lenders base the prepayment penalty fee on a percentage of the remaining balance.
Strategies for Paying off Your Loan Early
Even though paying off your car loan or personal loan early might be a really good idea for your finances, that does not mean it is necessarily an easy task to accomplish. If you have a limited budget, it might be particularly challenging to find room to pay off your loan sooner. There are some strategies and tips that might help you put more money towards the remaining loan balance each month.
Here are some important steps for making your financial goals possible:
Reevaluate Your Budget
Analyze your current budget to see how much money you are bringing in each month and how much you might be able to put towards paying early. Look closely at whether you can rearrange your budget a bit to have more money to put towards debt payments. Below are a few budget plans that can help you quickly pay off a personal loan.
| Strategy Method | Description | Best For |
| Debt Avalanche | Prioritize paying off debts with the highest interest rates first, then move to those with lower rates. This method saves on total interest paid. | Those with multiple debts, especially high-interest debts like credit cards. |
| Debt Snowball | Focus on paying off smaller debts first for quick wins, then tackle larger debts. This method provides motivational boosts. | Those who need psychological wins to stay motivated in debt repayment. |
| Zero-Sum Budgeting | Allocate every dollar of your income to specific expenses, savings, and debt payments, ensuring no money is wasted. | Those who want a highly organized and accountable budgeting system. |
| 50/30/20 Budgeting | Allocate 50% of income to needs, 30% to wants, and 20% to savings and debt repayment. Adjust the percentages to prioritize loan repayment. | Those looking for a balanced yet flexible budgeting approach. |
| Envelope System | Use cash for different spending categories placed in envelopes. Any leftover money in each envelope at the end of the month goes towards the loan. | Those who prefer using cash and need a tangible budgeting system. |
Minimize Unnecessary Spending
If something is not a necessity, it might be a good idea to cut that expense and reallocate it towards your loan balance. Stop ordering delivery for a while or cut the HBO Max subscription for a couple of months. You’d be surprised how quickly you can pay off your loan with a few minor sacrifices like these.
Round up Your Monthly Payments
Every time you make a monthly payment, round-up from the amount you usually pay. If you can only round up to the nearest $50 on your monthly installment, this will still speed up the process and help you pay the principal balance down faster, along with the interest payments. This will also work well for other high-interest debt you have, like cash advance loans and credit card debt. Round up your payment from the minimum payment.
Pay Twice a Month Instead of Once
Another option for increasing how much you put towards your loan each month is to pay twice every month instead of once. Biweekly payments can be an excellent way to keep yourself accountable by ensuring the remaining balance is at the forefront of your mind throughout the month.
Put Financial Windfalls Towards Paying off the Loan
Once in a while, we get hit by an unexpected financial windfall. This could look like a bonus at work or an impressive tax refund. A happy surprise like this will usually go to treat yourself and rightfully so. Typically, you might want to get yourself a spa weekend or a new tech gadget.
However, this is the perfect opportunity to take advantage of when paying off a loan early.
Resist the temptation of spending that windfall just this once and put it towards your personal loan or paying off your car. When you have one less financial obligation to worry about and you save money on interest, you will not regret it.
Bring in Extra Income
Now is the perfect time to ask for that raise at work or to launch your side hustle project. Increasing your income is the perfect way to pay off your loan exponentially faster than you would be able to with your income as it is now. If you aren’t due for a raise, look into the best paying part-time jobs near you. Some common side hustles that are perfect for increasing your cash flow include dog walking, food delivery apps, or ride-hailing services.
FAQs About Paying Personal Loans Early
Paying off personal loans earlier than scheduled can have a mixed impact on your credit score. Initially, it might cause a slight dip because it closes a credit account, which can affect your credit mix and average account age. However, in the long run, it reduces your debt-to-income ratio and demonstrates your creditworthiness. Just keep in mind, maintaining a variety of credit types and a good credit history is also key for a healthy credit score and credit report.
Absolutely! Making larger monthly payments on your personal loan can significantly reduce your loan term. By paying more than the minimum due each month, you reduce the principal balance faster, which in turn decreases the total interest accrued. This strategy can help you become debt-free sooner and save money on interest.
Yes, there can be significant differences in prepayment penalties among lenders. Some may not charge any penalty for paying off a personal loan early, while others might impose a fee to offset the interest they lose. It’s crucial to review your loan agreement or speak with your lender to understand their specific policies regarding early repayment.
Paying off credit card debt usually takes priority over a personal loan due to higher interest rates on credit cards. Credit card debt is also a revolving debt, which can more significantly impact your credit utilization ratio, a major factor in your credit score. However, if your personal loan has a higher interest rate or you’re nearing the end of its term, focusing on the loan might be more beneficial.
Before paying off your loan early, consider factors like prepayment penalties, your emergency fund status, and other debts. Ensure that paying off your loan ahead won’t deplete your savings or leave you financially strained. Also, compare the interest rates of your other debts; it might be more beneficial to pay off higher-interest debts first.
To calculate the interest you’ll save, first find out the remaining balance and interest rate of your loan. Use an online loan calculator to compare the total interest you’ll pay by sticking to your regular schedule versus paying off early. This calculation will give you a clear picture of the potential savings.
Paying off a loan early can positively impact your credit history, showing future lenders that you’re a responsible borrower. This can lead to better loan offers in the future, including lower interest rates and higher loan amounts. However, it’s also important to maintain a good credit mix and other healthy credit habits.
Early loan repayment can positively impact your financial health by reducing your debt burden and freeing up monthly income. It can improve your debt-to-income ratio, which is beneficial for future financial endeavors like applying for a mortgage. However, ensure that this decision doesn’t compromise your emergency fund or your ability to manage other financial responsibilities.
CreditNinja: How To Pay Personal Loans Early
Paying off online loans early can help you save a lot of money on interest fees. There are various ways to get enough money to pay off a personal loan early. For example, you could look for the best remote side hustles from home or weigh the pros and cons of working overtime.
For additional information on increasing your income and reducing your expenses, check out the CreditNinja blog for free financial tips.
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