Can You Pay Off a Personal Loan Early?

While you can technically pay off a personal loan early, lenders sometimes charge a prepayment penalty, and there are instances when those funds might be better used somewhere else.

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How Paying Off a Loan Early Saves You Money

Personal loans typically carry simple interest. That means interest only accrues on the loan's original principal. So if you pay off a personal loan early or more quickly, you can reduce the amount of what you owe.

Here's an example:

• Loan amount:

  $10,000 personal loan

• Interest rate:

  10%

• Original term:

  36 months — total interest paid: $1,616.19

• If paid off in 18 months:

  Total interest paid will be about $810

• Interest savings:

  Around $800

"If you are in a financial position to pay off a loan early, it's usually a good idea," said Kyle Enright, president of lending at Achieve. "You'll pay less interest. You'll have one less monthly payment to make, and hopefully could use that money for savings. Carrying less debt can improve credit profiles and scores in many cases."

4 Reasons You Shouldn't Pay Off Your Loan Early

While paying off a loan is often a smart financial move, consider the bigger picture — it might not be the best use of your funds.

"Make an honest assessment of your day-to-day finances," Enright said. "If paying off the loan early will leave you bereft of savings, without an emergency fund, or struggling to make ends meet, it may not be the best idea or the best timing."

Consult this four-point checklist to determine if you should pay a personal loan off early.

1. Do You Have Enough in Your Emergency Fund?

Experts generally recommend banking at least three to six months' worth of expenses in emergency savings. If your rainy day fund is currently lacking — or, worse yet, nonexistent — you're generally better served putting a windfall or extra funding into a high-yield savings account than paying off low-interest debt.

2. Compare The Interest Rates on All Your Outstanding Balances

Before you decide to pay off a personal loan early, consider if you have more expensive debts to take care of. One of the pros of personal loans is that they typically carry lower annual percentage rates (APRs) compared to other types of financing. The Federal Reserve, for instance, recently reported an average APR on a two-year personal bank loan of 11.14%.

However, borrowers with good credit can often qualify for rates in the single digits. Some of the best personal loans advertise APRs as low as 6.49%.

This chart below might help you figure out which debts to prioritize paying off.

3. Know Whether You'll Owe a Prepayment Fee

"Check your loan agreement, or directly with your lender, to see if the lender imposes a prepayment penalty," Enright said. "If so, calculate the savings in interest in paying off the loan early versus the amount of the penalty."

Many personal loans don't charge prepayment penalties. If they do, the fees are usually between 1% and 5% of your outstanding balance, meaning they're likely lower than your loan's interest rate.

However, they're still important to keep an eye on, especially if you have a high outstanding balance. A 5% prepayment penalty on a $50,000 loan, for instance, is $2,500.

4. See if There Are Other Investment Opportunities

If your loan has a low interest rate, putting any extra funds into a high-yield investment can earn you more.

This strategy is tricky, though. Investment returns aren't guaranteed, and you'll need an exceptionally low APR on your loan to make the option look good on paper.

How To Pay Off a Personal Loan Early

Paying off a personal loan early isn't all that different from making a regular payment, but there are a few things to keep in mind to make the most of it. Try these steps below:

1. Contact Your Lender For a Payoff Quote

You can usually do this online through the lender's app or website. The payoff quote includes the exact amount you'll need to pay to satisfy the loan, as well as the payment due date.

Remember — your payoff quote will usually be higher than the outstanding balance on your monthly statements. That final tally includes interest that accrues between your statement date and payoff date, along with any fees or prepayment penalties.

2. Choose Your Payoff Strategy and Make The Payment

You don't have to pay off your personal loan in one lump sum. You have several different payment options, such as:

• Biweekly payments

• An extra annual payment

• Higher payments

• Roundup payments

3. Get Written Confirmation

You'll usually receive a letter from your lender within 10 days of your final payment. This provides written documentation that you've satisfied your debt and the lender has closed the account.

If you had your loan set to autopay, cancel those recurring payments. Otherwise, you could incur accidental charges.

Take Control of Your Loan Payoff

Whatever strategy you choose, be sure to specify that extra funds are put toward principal, not interest or future monthly payments. That saves you the most money and results in the shortest loan term.

Some lenders let you automate principal-only payments, while others require notice each time — and a few don't allow them at all. It's best to find out what your lender accepts.

FAQs

Does paying off a loan early save interest?

Paying off a personal loan early will save you from paying additional interest. However, some lenders charge prepayment penalties. These penalties can take away any potential savings.

Will I owe any penalties or fees?

Some lenders charge prepayment penalties when you pay a personal loan off early to make up lost interest. Prepayment penalties typically cost 1% to 5% of the loan's remaining balance.

How do I know if it's worth it?

To determine if paying a personal loan off early is worth it, you'll have to do some math.

• First, calculate whether the interest you'll save is more than the prepayment penalty, if there is one.

• Second, compare the balance you'd pay to satisfy the loan to what you currently owe. This includes interest, fees and any other outstanding loan balances.

• Finally, consider your financial health. Ask yourself, "will those funds help me achieve more important goals, like building an emergency fund?"

Can I pay a little extra each month instead of all at once?

You can pay a little extra monthly on your personal loan to save on interest and reduce your loan's term. However, you'll need to specify that the extra money should go toward the principal. That way, the lender doesn't put the funds toward interest or hold them for future payments.

What happens to my credit if I pay it off early?

Paying off a loan early is likely to have a long-term positive impact on your credit score, as it reduces your outstanding debts and demonstrates your ability to repay. However, it may cause a short-term dip in your score, as it lowers the average age of your open accounts and can affect your credit mix.

Can you get another loan after paying one off?

You can usually apply for a new loan after paying off an existing one, although some lenders may have waiting periods, particularly for recurring customers. Your ability to get a loan depends largely on your credit score, income and overall financial profile.

Is it worth getting a personal loan to pay off other debt?

Personal loans are often used to consolidate debt, since they tend to have lower APRs than other types of financing, like a credit card. But whether a new personal loan is worth it depends on what other debts you are currently paying off, as well as the interest you could qualify for.

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