It might seem obvious to pay off a personal loan early, but there are other considerations you should be aware of before making your decision. One advantage of paying off debt early is the ability to avoid paying interest. Your debt-to-income ratio will improve, which could result in a rise in your credit score as well. But there could be drawbacks to these financial decisions. Some personal loans, for instance, come with prepayment penalties. Additionally, if you’re trying to establish credit, an early payoff could end a stellar track record of on-time payments and even result in a temporary drop in your credit score. Now that you know which option is best for you, let’s explore the specifics so you can decide with confidence.
Advantages of Paying Off Your Personal Loan Early
Maintaining excellent credit and improving your financial situation both depend on paying down debt and keeping it manageable. All of those things and more are accomplished by paying off a personal loan early.
You save money on interest.
The less interest you pay on a loan, the sooner you can pay it off. The potential savings can be significant because it ultimately lowers your total cost of borrowing. Consider this scenario: You had three years left on a $30,000 personal loan with a 10% interest rate, and you paid off $10,000 of it. You would save an estimated $6,000 in interest if you decided to pay off the remaining $20,000 balance early rather than paying $9,000 in interest over the course of the loan.
You’ll have more money in your monthly budget.
You’ll have extra money in your budget for other needs now that that recurring monthly payment is no longer there. You can use that money for regular expenses or put it toward important financial objectives like investing, creating an emergency fund, or saving for retirement.
You’ll lower your debt-to-income ratio.
Your debt-to-income ratio, which divides your income by the total of your debts, is a crucial factor considered by lenders when determining whether to grant you credit. You might see an improvement in your credit score* by reducing your debt-to-income ratio, and should you ever need a loan, you’ll be able to get one with better terms by doing so.
You gain peace of mind.
One less financial obligation can reduce stress related to monthly finances. The quicker you pay off a personal loan, the sooner you are free of that debt responsibility. But be cautious to avoid creating a financial burden for yourself by paying off your personal loan early. Before making a choice, make sure you can afford your regular monthly expenses without stress and have money set aside in case of emergency. Avoid taking money out of your retirement or savings accounts, as doing so could cost you more money in the long run.
Disadvantages of Paying Off Your Personal Loan Early
While it can reduce your debt load, save you money, and reduce your interest payments, there may be some drawbacks. Here are three possible impacts to consider.
You might owe a prepayment penalty.
Prepayment penalties are a way for some lenders to recover the interest they would otherwise lose if a loan is repaid early. Typically, this sum is determined as a percentage of the outstanding principal balance of the loan at the time of payoff. Before making a decision, carefully review your loan documents and perform the math. Despite the fact that you’ll save money on interest, a prepayment penalty may lessen or even eliminate that benefit, particularly if your loan has a low, fixed interest rate or a shorter term. Before applying for a personal loan, be aware that not all lenders include prepayment penalties in their loan terms if you intend to pay off the loan early. For instance, LendingClub doesn’t impose any fees or penalties for early loan repayment, so you can do so and save money on interest without being concerned about the consequences.
Your credit score could be affected.
Your credit mix and credit history change after you pay off a personal loan, which could have an impact on your credit goals. Your credit report will show a personal loan as an installment loan account, complete with the precise loan amount and repayment terms. Because payment history accounts for the majority of your credit score, maintaining a long history of on-time monthly payments can be advantageous for your finances in the long run. You could lose months (or even years) of a good payment history if you pay off your personal loans early. In addition, maintaining a well-managed mix of credit, such as credit cards, student loans, or auto loan accounts, to name a few, and the credit age of all your accounts have an impact on your score. In light of those crucial indicators, paying off a personal loan early might actually result in a brief drop in your credit score.
You may have smarter money options.
Your money might be better used elsewhere if the interest rate on your personal loan is lower than the rates you are being charged on other types of debt. You could put more effort into paying off higher-interest debt, like a credit card balance, as opposed to paying off your personal loan early, which could end up saving you more money overall. A high-yield savings account or increasing your retirement plan contributions at work to qualify for an employer match are other options to think about. Of course, you should always check your bank accounts to make sure you have enough money to cover both your anticipated monthly expenses and unanticipated emergencies before making changes to your monthly contributions or paying off a personal loan early. Making plans for the future could relieve a lot of your stress.
Does LendingClub Charge Prepayment Penalties or Fees?
Personal loan rates, fees, and terms vary widely by lender. Studying the specifics of your offer is crucial to ensuring that you don’t pay more than is necessary or what you can comfortably afford. With LendingClub, you can pay off your personal loan early or make additional monthly payments at any time without incurring any fees or penalties for early repayment. Any additional payments you make on top of your regular monthly payment go toward lowering the loan’s principal. With that flexibility, you can lower the total amount of interest you pay without worrying about additional costs.
The decision to pay off your personal loan early ultimately rests heavily with the lender. Consider all possible costs before making a choice, weigh the benefits and drawbacks, and weigh what you might gain in the short term against your longer-term credit and financial goals. Consider lenders like LendingClub who don’t impose penalties or fees for early repayment if you can prepare to pay off a personal loan in full before taking out the loan.
FAQs About Paying Off Your Personal Loan Early
Yes. You can avoid paying interest by paying off your personal loans early and ending your monthly payments. Less interest equals more money saved.
What is a prepayment penalty and why do they exist?
Some lenders charge a fee known as a prepayment penalty when borrowers pay off all or part of a loan before the term of the contract expires. Prepayment penalties effectively discourage borrowers from repaying loans early, which prevents lenders from collecting interest payments. Working with a lender that doesn’t charge a prepayment penalty is the best way to avoid one. For instance, at LendingClub, there are no additional fees for making additional payments or paying off your loan in full whenever you want.
Will paying off my personal loan early hurt my credit score?
Because it alters your credit mix and history, paying off a personal loan early is probably not going to increase your credit score, but it also won’t necessarily lower it. However, keeping some types of installment debt open, like a personal loan, can actually help your credit score by boosting your history of on-time payments. Reducing revolving debt, like paying off your credit cards, can help improve your score by lowering your debt-to-income ratio. *.
*Improving your credit score may result from paying down debt and keeping credit card balances low, but outcomes are not ensured. Based on a variety of variables, including but not limited to payment history and credit utilization, individual results may vary.
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FAQ
What happens if you pay off an installment loan early interest?
Some lenders charge a fee known as a prepayment penalty when borrowers pay off all or part of a loan before the term of the contract expires. Prepayment penalties effectively discourage borrowers from repaying loans early, which prevents lenders from collecting interest payments.
Can you pay back installment loan early?
In conclusion, you can pay off your installment loan early if you work with the right lender, and we do recommend it. There are numerous ways to build credit that won’t cost you anything in monthly interest, and doing so won’t harm your credit score.
Does paying off an installment loan hurt your credit?
Making monthly payments on time raises your credit score and improves your credit mix. An installment loan’s repayment will result in a small, temporary drop in credit score.
Do you get penalized for paying off a loan early?
While paying off a loan early is typically regarded as a good thing, some lenders charge you a fee for doing so. You can prevent this annoying expense by reading your loan contract carefully for a prepayment penalty before you sign.