Should You Pay Off Your Personal Loan Early?

There are many reasons why people take out a personal loan, including vacation costs, wedding expenses, home remodeling, and more.

Being stuck in debt is stressful, and punishment for defaulting on the loan can take the form of a lawsuit, a drop in your credit score, or hefty late payment fees. That is why it’s crucial to do everything in your power to repay your debt as fast as possible. You may have heard that paying off what you owe as early as possible can help you save some extra bucks in the long run, which is sometimes the case.

In general, the longer you are bogged down paying back a debt, the more interest you will pay over the loan term. Hence, it seems a good idea to pay off your loan early. However, before you wrap up your payments several months earlier, there are some things you need to consider.

Is It Possible?

Yes, it’s possible to repay your loan early, helping you shave off a few months from your repayment period. But take note that some lenders might ask for a prepayment penalty fee for paying off the loan early.

This fee is either an amount that shows how much the lender will lose in interest if you pay off the loan early or computed as a percentage of what you have left to pay on the personal loan. Additionally, keep in mind that how the penalty is calculated will vary from lender to lender.

Also, all the penalties are generally included in your loan agreement. On that note, if you decide to pay off your personal loan before the end of the loan term, call your lender or check your loan documents to ensure you won’t be charged a prepayment penalty fee.

Will It Affect Your Credit Score?

When it comes to paying off your credit card debt, you reduce the amount of debt relative to your credit limit. Meaning, your credit utilization rate is lowered; thus, improving your credit score.

However, personal loans don’t work the same since they’re installment debts. On the other hand, credit card balances are revolving debts, which means you can borrow more cash up to your maximum credit limit as you make payments. Plus, there is no set repayment period.

Take note that installment debt requires you to pay off what you owe in equal, regular amounts within a set repayment period. Once you’ve wrapped up the debt, the account is then closed.

When you repay a personal loan early, it will show a shorter account lifetime in your credit report. Remember that the longer your credit history is, the higher your credit score. With that said, you may reduce your average credit score and credit history length if you pay off a personal loan early. A low credit score might make it hard for you to get a job, good financial products, or a home.

On top of that, when you pay off the debt early, you will lose the chance to make timely payments. Note that the more timely payments you make, the more it’ll help boost your credit score.

Things to Keep in Mind

Here’s a rundown of things to keep in mind if you decide to pay off your personal loan early.

  • Monthly Expenses. Consider your monthly expenses first before deciding to pay off your debt in advance. It doesn’t make sense to pay off your loan early if it gets in the way of your living expenses.
  • Interest Rate. Make sure to compare the interest rate of the loan you want to pay off in advance to your other debts. In general, debts such as credit card balances often come with expensive rates. Meaning it makes more sense to repay them first. By paying off the debts with the highest interest rate, you will save more on interest fees in the long run.
  • Retirement Funds. Saving for retirement is vitally important, no matter how old you are. If possible, you should be saving money for your retirement and not take out money from this account. As such, don’t use your retirement money to pay off your personal loan early; doing so could lead to hefty tax consequences.
  • Emergency Savings Account. An emergency savings account is designed to help you pay for unexpected expenses such as car trouble or medical bills. Establishing an emergency savings account is something you should consider before repaying your loan early.

Bottom Line

Is debt consolidation a good reason to take out a personal loan, or is an emergency a good reason for a loan? Well, both reasons make sense for getting a personal loan. Personal loans can be an affordable and convenient way to pay for a large expense.

What’s more, when used responsibly, it can improve your credit history. However, it would be best to consider whether your situation would allow you to take advantage of a personal loan. Paying off the loan in advance may leave you in a place where you’ll likely undo any money you had saved on interest, pay a prepayment penalty, and it can hurt your credit history.

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Michael launched Your Money Geek to make personal finance fun. He has worked in personal finance for over 20 years, helping families reduce taxes, increase their income, and save for retirement. Michael is passionate about personal finance, side hustles, and all things geeky.