At a Glance
The decision to pay off a personal loan early comes down to two basic questions: What is the interest rate, and are there early repayment penalties if you pay it off before the agreed-upon loan term ends? The pros and cons of paying off loans we’ve listed here are derivatives of these two factors. We’ve included some hypothetical scenarios to help you better understand this and understand what happens when you pay off a personal loan early.
The Pros: Benefits of Paying Off Personal Loans Early
If you have high-interest credit card debt in addition to a personal loan, focus on paying that off first. The decision for early payoff should come when you have the personal loan isolated, since it’s likely the debt account with the lowest interest rate. If your personal loan rate is higher than your credit card interest rates, pay the personal loan off first. Here are the benefits of doing that:
- You Could Save Money: There may be an early repayment fee, so take that into account before you pay off your personal loan early. Minus that, you’ll save money by not having to pay interest on borrowed money. Every month you shorten the loan saves you a few dollars.
- You Could Increase Your Credit Score: One of the primary variables in calculating your credit score is “amounts owed.” That number will adjust in your favor if you pay off a personal loan early. It might take a month or two, but you’ll see your score go up.
- You Will Have More Freedom from Debt: This is the most obvious benefit of early repayment. Eliminating that monthly loan payment will free you up to save, invest, or simply spend more money on the things you’ve always wanted.
Drawbacks of Paying Off Personal Loans Early (Cons)
Let’s talk a bit about interest rates again. If your personal loan has a low interest rate, say 5%, it’s not worth it to pay it off early. That money is better off in an investment account that will pay you a healthy return. The same principle applies if you have credit cards with rates of 15% or higher. Pay those first because they’re costing you the most money.
- You Might Miss Investment Opportunities: The S&P 500 is up 20% this year. You can take your extra money and potentially earn that 20% or you can spend it on a loan repayment to save 5%. Do the math. This is a scenario where paying off the loan is a bad idea.
- You Might be Penalized: Some lenders charge an early repayment penalty. That’s a con for sure, but it doesn’t mean that early repayment won’t be worth it. Calculate what you’ll save with the penalty included.
Commonly Asked Questions
Why is it bad to pay off a loan early?
Personal loans typically have lower interest rates than credit cards and aren’t costing you as much as you could make on investment returns. Pay the credit cards first, invest any extra money into a high-yield investment account, and let the loan run its course.
If I pay off a personal loan early, will I pay less interest?
Yes, you will pay less in interest, but you might have to pay an early repayment penalty.
Does paying a loan off early save you money?
It will if the amount of the penalty does not exceed the total interest payments you eliminate by closing the loan out early.