Paying your personal loan off early can offer some financial benefits. Depending on how your loan is structured, you could save a lot in interest costs, and freeing up the money you normally spend on the loan payment adds some cash back to your monthly budget.
But does paying off a loan early hurt your credit, and are there other downsides to doing so? Find out more about paying off a personal loan early below, including some tips for doing so while minimizing any potential disadvantages you might face.
Can You Pay Off a Personal Loan Early?
Yes, you’re allowed to pay off personal loans early. The better question is, “Should you pay off your personal loan early?” It’s important to weigh the pros and cons relevant to your specific situation before you pay off personal loans outside of the planned term.
To understand whether you should pay off a personal loan, first consider the general benefits and disadvantages that can apply.
| Potential Benefits of Paying Off a Personal Loan Early | Potential Disadvantages of Paying Off a Personal Loan Early |
| You might save interest.Â
You pay interest over the life of your loan, and paying down the principal of the loan faster than originally planned reduces how much you pay in interest. That’s because the interest is calculated on the principal amount, and if you pay some of that off early, the interest is calculated on a lesser amount. Depending on how your loan is structured and how fast you can pay it off, you might save hundreds or even thousands of dollars in interest payments. |
You might pay a penalty.Â
Some lenders build penalties into the loan structure that can lead to you paying fees if you try to pay the loan off early. They do this because if you pay the loan off early, you pay them less in interest. Interest is a primary way lenders make money, so some build other fees into the loan to ensure they get some money whether or not you pay off the loan early. |
| You free up money for the month.Â
Paying off your personal loan early leaves more money in your pocket every month. If, for example, your monthly payments are $200, that’s $200 a month you can start saving. You may be able to earn interest on that savings, and starting as early as possible by paying off your loan to free up the money can mean more savings down the road. |
You might reduce your credit mix.Â
One aspect of your credit score is your credit mix. Creditors like to see that you can handle a healthy mix of installment and revolving debt. If your personal loan is your only installment account and you pay it off early, the lender closes the account. That means you won’t have an open installment account listed on your credit report, reducing your credit mix. |
| You reduce your debt-to-income ratio.
Many lenders consider debt-to-income ratios when evaluating you for credit. This is especially true for larger loans such as mortgages or auto loans. Your debt-to-income ratio is how much in debt payments you have each month compared to your income. To get approved for a mortgage, your DTI must typically fall below a specific threshold, and paying off some of your debt early can help you get there. |
You may increase your credit utilization rate.Â
When your personal loan account is closed, that’s technically a line of credit removed from your credit report. This can increase your credit utilization rate, which might impact your credit score. |
| You don’t have to worry about the loan.Â
Life gets busy, and every financial detail you must attend to can add to your personal workload. Sometimes, reducing the number of bills you need to pay each month can help you streamline your money management for better outcomes. |
You might drop your overall credit age.
Another factor that makes up your credit score is how long you’ve had credit and, on average, how long you’ve had your various accounts. If your personal loan is one of the older accounts you have and you pay it off, you can drop your overall credit age. |
Whether or not you should pay off your personal loan early depends on how the considerations above relate to your current financial situation.
For example, if you’re just looking to save the interest cost, make sure you do some calculations. Start by figuring out exactly how much you might save. Then look at what it might cost to pay off the personal loan, including potential prepayment penalties and any impact to your credit. If you’re thinking about getting a new credit card or loan soon, will the potential hit to your credit result in a higher interest rate and more expense at that time? In this case, the disadvantages of paying off the personal loan early may outweigh the benefits.
On the other hand, if you’re preparing yourself to apply for a mortgage and need to lower your debt-to-income ratio, the benefits of paying off a personal loan early may outweigh the disadvantages. In the end, it’s a decision you must make for yourself after considering all the facts of your situation and loan.
5 Tips for Paying Off Your Personal Loan Early
If you decide that paying off your personal loan early makes sense for your situation, follow the steps below to increase your success in doing so.
1. Check for Prepayment Penalties on Your Personal Loan
Start by going through your loan paperwork to find out if there are any prepayment penalties. These are fees charged by lenders to help them recoup some of the money you would have paid in interest if you paid the loan off over the course of the entire term.
Note that not every personal loan has prepayment penalties. These fees must also be disclosed before you sign the loan and included in the written documentation about your loan. A lender can’t suddenly decide to charge these fees if you opt to pay off your loan and they haven’t previously disclosed them.
The existence of prepayment penalties doesn’t mean you shouldn’t pay off a loan early. However, it can change how much you have to pay to do so. You should also consider the total cost of those early payment penalties against the costs of paying your loan off over the entire term to understand which might be better for your finances in the long term.
2. Make Additional Payments Toward Your Principal
If you want to pay off a loan early and can drop the entire payoff amount in one go, that’s obviously the fastest way to go. But many people don’t have that kind of money to throw at a loan, so a more common way to pay off a loan early is to make extra payments on the principal balance.
You can do this by adding money to your loan payments or by making extra payments throughout the month. For example, if you’re supposed to pay $125 per month, you might pay $150 per month. The extra $25 can go toward paying down your principal faster. Alternatively, you might make two payments of $125 a month, with the second payment going entirely toward your principal balance.
When paying extra on a loan balance this way, it’s critical to pay attention to the details. Make sure it’s clear to your lender that you’re making extra payments on the principal of the loan. Otherwise, they may apply the extra payments toward your next month’s personal loan payment. While this helps you get ahead and pay the loan off faster, it may mean those extra payments are, in part, used to pay interest and not entirely put toward the principal balance.
Many lenders have options to ensure you can pay directly to the principal balance as long as you’re current with regular payments. If you mail a check to pay for your loan in response to a bill or with a ticket you tear out of a book, there’s usually an option on that piece of paper to indicate whether any extra you’re paying should go toward the principal. If you make your payments online and pay extra, most online payment processes ask if that extra should be applied toward your next payment or the principal of the loan.
Another important note is that if you do pay extra and ask for it to be applied to the principal balance, it does not count as getting ahead on your scheduled loan payments. You would still owe your next payment as agreed, and failing to make it could lead to late charges or other additional expenses.
3. Stick to a Budget
Paying off a personal loan early requires throwing more money at it than you might have planned. That might require finding some extra cash in your budget.
Look at your monthly expenses and compare that to your income to find extra money you can funnel toward your personal loan every month. You might do this by cutting out unnecessary expenses, such as eating out, or by increasing your income with a part-time job in the gig economy.
However you come up with the money to add extra payments to your loan every month, you only reach success if you stick with your plan. Track your income and expenses each month to ensure you’re sticking to the budget so you can pay off your loan early.
4. Refinance Your Personal Loan
In some cases, you might pay off your personal loan early without finding money in your budget. You do this by refinancing the loan, which means taking out a new loan to cover it.
Obviously, this tactic doesn’t leave you free of a personal loan payment. But it can reduce how much the loan costs you or how much you have to pay each month. That’s often the case when the original personal loan had extremely high interest rates or other poor terms. If you’ve improved your credit situation since you took out the first loan, you may be able to get a new loan with better rates and terms by refinancing, potentially saving yourself a lot of money in the long run.
5. Prepare for Loan Repayment With an Emergency Fund
Finally, avoid using your emergency fund or wiping out personal savings to pay off a personal loan early. While you might save yourself some money in the short term, what happens if an emergency comes up soon? You’re left without the cash to cover it, which could mean you have to turn to a high interest credit option. That can result in you spending more in the long run.
Will Paying Off Your Personal Loan Affect Your Credit Score?
Yes, paying off your personal loan early can have an effect on your credit score. Typically, the impact to your score is negative, in that your score might drop temporarily. That’s because, as noted in the table earlier in this article, paying off a loan early can result in:
- An increased credit utilization
- A lower credit age
- A less robust credit mix
It can be confusing because the opposite is actually true with a credit card. When you pay down a credit card balance, you decrease your credit utilization ratio. That’s because the account remains open, and you still have the line of credit associated with the card (as well as the credit age and mix).
The good news is that if you’re being responsible with your finances and actively working to improve your credit, any hit you take from paying off a personal loan early is likely to be temporary.
Frequently Asked Questions
What is the Most Common Use of Payday Loans?
Payday loans are used to meet short-term financial requirements when the borrower does not have sufficient funds to pay for bills or other expenses. The lender agrees to give the borrower a cash advance at high-interest rates. This loan is also known as a “payday loan” because the borrower uses it to pay off their debts until they get a check.
Payday loans are often considered a last resort option, but many people turn to these services when they need quick access to cash and do not want to wait in long lines at banks.
Cash advances are attractive for people who feel trapped by rising debt, can’t pay their credit card bills, or don’t want to travel to the bank to seek a traditional loans.
Many consumers believe that payday loans can be less risky and more affordable than larger loans. In fact, borrowers could face problems such as late mortgage payments or repossessions if they miss several payments. But, many states require that lenders charge higher interest rates for these loans.
Payday loans should be repaid within 14 days. In addition, remember that once you borrow money, you must agree to pay extra fees for each additional day of borrowing. The fees will vary depending on how much you borrow, but the majority of lenders charge $15 for every $100. Payday loans are available online.
With a 500 credit rating, can I get a loan for payday?
Low credit scores are not advised to take out payday loans. They have high interest rates and can require long repayment terms. Those who are eligible for these loans need to be familiar with all terms.
There are many lenders that offer special financing options for customers with poor credit scores. This allows them to get the money quickly. These options include:
- Installment Plans
- Extended payment schedules
- Lower APRs
- No-fee application
- Cash advances
Although there are exceptions, most people should not apply for payday loans. They are often expensive and difficult to get.
What app allows me instantly to borrow money?
The benefits of a simple business idea should be more important than the features. This is about solving people’s problems. It is important to identify the problem that your product will solve. Next, identify your users and what they can benefit from your product. Only then do you move on to developing an MVP (Minimum Viable Product).
What credit score is required for a payday loan application?
A high credit score should not be required for a payday loan as they are usually short-term loans, and this will help you repay quickly without any hassle.
However, if you plan to borrow money over a more extended period, you may face difficulties if your credit score isn’t good enough.
You may have to look for another type of financing that does not require good credit. If you plan to purchase a high-end item such as a car or other expensive items, you may need to apply for a credit card.
Statistics
- The loans usually can be rolled over for additional finance charges, and many borrowers—as high as 80% of them—end up as repeat customers.89 (investopedia.com)
- In California, for example, a payday lender can charge a 14-day APR of 460% for a $100 loan.6 Finance charges on these loans also are a significant factor to consider, as the average fee is $15 per $100 loan.1 (investopedia.com)
- Those protections include a cap of 36 percent on the Military Annual Percentage Rate (MAPR) and other limitations on what lenders can charge for payday and other consumer loans. (consumerfinance.gov)
- If you’re preparing your bank account for the charges that WeLoans will cost to find a lender, put that thought aside because it’s 100% free. (abcactionnews.com)
- Upgrade The company offers a 3 percent cash back on Auto, Health, and Home categories and a 1 percent cash back on the rest. (abcactionnews.com)
External Links
consumerfinance.gov
americanbanker.com
How To
The Best Military Payday Loans
According to several reports, one out of every five Americans currently serves in the armed forces. According to Department of Defense, veterans represent approximately 1/5 of the unemployed in the country. Millions of Veterans who served our country face financial hardship when they return.
Finding affordable financing options for active duty members and their families can be difficult. In some cases, this is because there is not enough credit available. These individuals are often unable to obtain the funds they need to pay their bills or buy essential necessities because lenders won’t lend money to them if they have poor credit scores.
There are many options for payday loans that can help you get your finances back on track. A personal loan from a bank or credit union is one option. Another option is looking into government programs such U.S. Department of Veterans Affairs (VA), or U.S. Treasury Department’s Paycheck Protection Program. But if you need extra cash fast, you might consider looking into short-term installment loans.
