Paying Off Personal Loans Early: Is It Worth It?

Can you pay off personal loans early?

Yes, you can almost always pay off a personal loan early. Doing so can help save you money on your interest.

However, it’s important to check with your lender and ensure they don’t charge a prepayment penalty, which is a fee for paying off your loan early or ahead of schedule. These fees can start at 2% of the outstanding balance if you pay your loan off in the first year, but penalties decline for each subsequent year until it’s 0%.

Before paying off your loan early, read your loan’s terms and conditions carefully to ensure you won’t be charged a prepayment penalty. If not, it can be a good idea to pay off your loan as quickly and early as possible.

When should you pay off a loan early?

There are a few times you should consider paying off a loan early, assuming you won’t be charged a prepayment penalty for doing so:

• You already have an emergency fund in place so that you’re covered if there’s an emergency or unplanned expenses. Experts recommend having at least six month’s worth of expenses tucked away in an emergency fund.
• You don’t have other types of debt with higher interest rates, such as credit card debt. If you do, it may be better to pay those off first.
• You’ve considered investing your additional funds and determined that paying off your personal loan would save you more money than you could earn by investing the money elsewhere.
• You have a good credit score with an established credit history, a solid credit mix, and other debt you’re paying off to continue building a payment history.

Is it good to pay off loans early?

There are both benefits and drawbacks to paying off a personal loan early:

Learn more: Pros and Cons of Paying Off Personal Loans Early

Tips to pay off personal loans early

If you determine that paying off your loan early is the best option, there are a few steps you can take and tips to follow to make doing so easier and faster.

1. Break down your payments

First, check that your lender doesn’t charge prepayment penalties. If they don’t start by breaking down your monthly loan payment into bi-weekly payments, meaning you make two payments per month instead of one. This will speed up the payoff process while also reducing the total interest you pay. If possible, try to also pay a little more with each payment.

For example, say your personal loan monthly payment is $300. You can make two payments of $175 each month, so you’re putting an extra $50 a month toward your balance.

Additionally, by breaking down your payments this way, you’ll be making one additional payment per year.

This can be a good option if you receive bi-weekly paychecks and can put a little bit of each one toward your debt while not overdoing it and affecting your monthly budget.

2. Make extra payments when possible

Even if you can’t make higher payments each month, try to make extra payments when you can. This helps pay down the debt faster and saves you money on interest.

Take advantage of the times you may receive unplanned income, such as money for holidays, birthdays, bonuses, or other extra savings throughout the year. Put some money aside to contribute to the loan each time you skip going out to dinner or buying an extra pair of shoes.

Remember, you don’t have to make extra payments every month. If your budget is tight, skip making the extra payment that month. Just ensure you’re making at least the minimum monthly payment.

3. Try adding to your income

Adding an additional source of income can be a great way to pay off your loan early. This can be:

• Picking up additional shifts at work
• Babysitting, pet sitting, or house sitting
• Food or grocery delivery
• Driving for Uber or Lyft
• Starting a side hustle
• Consulting
• Selling your crafts or work, such as on Etsy
• Selling items you no longer need, like clothes, accessories, electronics, furniture, books, or other items

If you have additional income, you can put more money toward paying off your loan each month while your primary source of income is used for other necessary expenses and savings.

4. Revise your budget

One easy way to find extra funds to contribute to paying off your loan is by revising your budget. If you don’t already have a budget, you can create one now and use it as a baseline. Doing so can help you track your income vs. your spending and find ways where you can cut back and save.

Start by writing down all your sources of income. Then subtract all required monthly expenses, like mortgage/rent, groceries, gas, utilities, internet, phone, and others. Then write out everything you spend on “wants,” like shopping, eating out, entertainment, and others. Decide where you can cut back on “wants” spending, or even how you can generate savings on your necessary expenses.

Any extra funds you find by revising your budget can be put toward paying off your loan.

5. Consider refinancing or debt consolidation

Refinancing allows you to transfer your current debt into a new loan with a lower interest rate or different repayment plan. This can lower your monthly payments and help you get out of debt faster.

Learn more: Refinance Personal Loan

Similarly, debt consolidation is using a loan with a lower interest rate and/or better repayment plan to pay off multiple high-interest loans, combining your payments into one and helping you save money on interest.

Related: Debt Consolidation Loans

These options aren’t right for everyone. For example, you should only consider them if you can get a lower interest rate on a new loan. You’ll also want to consider the cost of any fees. However, if you have a high credit score and can get a better interest rate or terms, you may be able to save money and pay off your debt sooner.

Does paying off a personal loan early hurt your credit?

Paying off a personal loan can in fact hurt your credit, but the effect will usually be temporary. When you pay off a loan, you’re minimizing your credit mix, eliminating a source of payment history, and decreasing your credit utilization. All of these factors affect your credit score, so lowering or eliminating them can lower your score.

If you have a solid credit mix or a longer credit history, you may not see as much of an impact.

Related: Why Do Credit Scores Drop After Paying Off Debt

This may seem counterintuitive since by paying off a loan early you’re demonstrating responsible borrowing habits. The good news is you won’t see a huge negative impact on your credit score, and it will rebound over time. Plus, once you pay off the loan, it’s marked as a closed account in good standing on your credit report and will remain on your report for 10 years (which can help your score).

It’s important to weigh the pros and cons of paying off a loan early. If you have a little credit history or credit mix, the risk may outweigh the benefits. It’s also important to keep in mind your future financial and borrowing needs. If you don’t plan on taking out another loan for several years, the impact on your score by paying this one off likely won’t affect you that far down the line.

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