Unlike student loans or mortgages, personal loans have a relatively short repayment timeline — typically around two to five years. Still, there may be situations when you want to pay off the remaining balance on a personal loan even faster. Is that possible? The short answer is “yes” and, in many cases, it can be a wise decision.
But if there’s a prepayment penalty, then this loan payoff may be more costly than you’d expect. Learning how a prepayment penalty might affect your payoff amount can be helpful in making the decision whether or not to pay off a personal loan early. And if you’re gathering information about a personal loan early payoff without incurring a prepayment penalty, you do have some options.
How to Manage Your Personal Loans
Securing a personal loan may be top of mind for borrowers, but just as important is figuring out how to repay the debt. Having some basic info on hand — such as your monthly take-home pay, the cost of your essentials and non-essentials, and short- and long-term savings goals — will help.
While there’s no one-size-fits-all strategy to budgeting, here are two popular budgeting methods to consider:
• 50/30/20 budget. With the 50/30/20 budget strategy, your take-home pay falls into three main buckets, according to percentages: 50% to “needs” (housing, utilities, groceries, etc.), 30% to “wants” (take-out meals, entertainment, travel costs, etc.), and 20% to savings (emergency fund; IRA or other retirement contributions; debt repayment and extra loan payments, etc.)
• Zero-Sum Budget. This type of budget calls for earmarking every dollar you earn for either savings or discretionary spending. First, you assign monthly after-tax income dollars to non-negotiable bills, such as rent and groceries. Then you assign leftover funds to discretionary spending and saving, which could include making extra payments on a personal loan.
Tips to Pay Down Your Personal Loan
Creating a budget is one tool to consider, but here are other loan repayment strategies you may want to explore if you want to pay off the debt faster.
• Switch to biweekly payments. Ramping up payments from once a month to twice a month could help you reduce the principal amount of a loan — and potentially pay off the debt — faster. It may even decrease how much interest you end up paying over the life of the loan.
• Make extra payments when possible. Exceeding your minimum loan payments
may help accelerate your loan repayment and potentially minimize the cost of high interest rates.
• Tap a second source of income. Starting a side hustle is one way to boost your income, and you can put the extra cash toward your debt. You can also use tax returns, work bonuses, even birthday gifts to pay down a personal loan faster.
• Refinance your loan. When you refinance a loan, you’re essentially replacing your old loan with a new loan that has a different rate and/or repayment term. Depending on the new rate and term, you may be able to save money on interest and/or lower your monthly payments.
• Round up monthly payments. Over time, rounding up payments to the nearest $50 or $100 could slightly accelerate your payment schedule.
It’s important to note that many personal loans come with early payment fees, which could undo whatever money you would have saved on interest. More on that below.
💡 Quick Tip: Fixed-interest-rate personal loans from SoFi make payments easy to track and give you a target payoff date to work toward.
Can You Pay Off a Personal Loan Early?
It’s unlikely that a lender would refuse an early loan payoff, so yes, you can pay off a personal loan early. What you have to calculate, though, is whether it’s financially advantageous to do so. If a personal loan early payoff triggers a prepayment penalty, it might not make financial sense to do so.
Understand Prepayment Penalties
If and how a prepayment penalty is charged on a personal loan will be stipulated in the loan agreement. Reviewing this document carefully is a good way to find out if the penalty could be charged and how your lender would calculate it.
If you can’t find the information in the loan agreement, ask your lender for the specifics of a prepayment penalty and for them to point out where it is in the loan agreement.
There are a few different ways a lender might calculate a prepayment penalty fee:
• Interest costs. In this case, the lender would base the fee on the interest you would have paid if you had made regular payments over the total term. So, if you paid your loan off one year early, the penalty might be 12 months’ worth of interest.
• Percentage of your remaining balance. This is a common way for prepayment penalties to work on mortgages, for example, and you’d be charged a percentage of what you still owe on your loan.
• Flat fee. Under this scenario, you’d have to pay a predetermined flat fee for your penalty. So, whether you still owed $9,000 on your personal loan or $900, you’d have to pay the same penalty.
It may sound strange that a lender would include this kind of penalty in a loan agreement in the first place. Some lenders may, though, to ensure you’ll pay a certain amount of interest before the loan is paid off. It is an extra fee that, when charged, helps lenders recoup more money from borrowers.
Avoiding Prepayment Penalties
If your loan has a prepayment penalty, it could be in effect for the entire loan term or for a portion of it, depending upon how it’s defined in the loan agreement. However, you have some options.
For starters, you could simply decide not to pay the loan off early. This means you’ll need to continue to make regular payments rather than paying off the personal loan balance sooner. But this will allow you to avoid the prepayment penalty fee.
Or, you could talk to the lender and ask if the prepayment penalty could be waived.
If your prepayment penalty is not applicable throughout the entire term of the loan, you could wait until it expires before paying off your remaining balance.
Another strategy is to calculate the amount of remaining interest owed on your personal loan and compare that to the prepayment penalty. You may find that paying the loan off early, even if you do have to pay the prepayment penalty, would save money over continuing to make regular payments.
Recommended: How to Avoid Paying a Prepayment Penalty
Does Paying Off a Personal Loan Early Affect Your Credit Score?
Personal loans are a type of installment debt. In the calculation of your credit score, your payment history on installment debt is taken into account. If you’ve made regular, on-time payments, your credit score will likely be positively affected while you’re making payments during the loan’s term.
However, once an installment loan is paid off, it’s marked as closed on your credit report — “in good standing” if you made the payments on time — and will eventually be removed from your credit report after about 10 years.
So does paying off a loan early hurt your credit? Short answer, yes. Paying off the personal loan early might cause it to drop off of your credit report earlier than it would have, and it may no longer help your credit score.
If You Pay Off a Personal Loan Early, Do You Pay Less Interest?
Since a personal loan is an installment loan with a fixed end date, if you pay off a personal loan early, you won’t pay less interest. You won’t owe any interest anymore because the loan will be paid in full.
Advantages and Disadvantages of Paying Off a Personal Loan Early
There are definitely some advantages to personal loan early payoff. One obvious benefit is that you could save on interest over the life of the loan.
For example, a $10,000 loan at 8% for 5 years (60 monthly payments) would accrue $2,166.50 in total interest. If you could pay an extra $50 each month, you could pay the loan off 14 months early and save $518.42 in interest.
Not owing that debt anymore can be a psychological comfort, potentially lowering bill-paying stress. If you’re able to make that money available for something else each month — maybe creating an emergency fund or adding to your retirement account — it might even turn into a financial gain.
If you no longer owe the personal loan debt, you’ll essentially be lowering your debt-to-income ratio, which could positively affect your credit score.
That said, if your personal loan agreement includes a prepayment penalty, paying off your personal loan early might not be financially advantageous. Some prepayment penalty clauses are for specific time frames in the loan’s term, e.g., during the first year.
If you pay off the loan during the penalty time frame, it could cost you just as much money as it might if you had just paid regular principal and interest payments over the life of the loan.
You might be thinking of a personal loan early payoff so you can put your money to work somewhere else. But if the interest rate on the personal loan is relatively low, it might make financial sense to put your extra money toward higher-interest debt, or to contribute enough to an employer-sponsored retirement plan so you can get the employer match, if one is offered.
Another thing to consider is whether paying off your personal loan early will hurt your credit. As mentioned above, making regular, on-time payments to an installment loan like a personal loan can have a positive effect on your credit score. But when the loan is paid off, and marked as such on your credit report, it’s not as much help.
|Advantages of early personal loan payoff||Disadvantages of early personal loan payoff|
|Interest savings over the life of the loan||Possible prepayment penalty|
|Could alleviate debt-related stress||Extra money could be better used in another financial tool|
|Lowering your debt-to-income ratio||Removing a positive payment history on the loan early could negatively affect your credit|
|More cushion in your monthly budget||Taking money from another budget category might leave an unintentional financial gap|
What Happens If You Don’t Pay Back a Personal Loan?
Let’s say your personal loan payment is due by the 1st of every month. One month, the 10th arrives and you realize you haven’t paid what you owe. You’ll likely be considered delinquent on the loan. You may also be hit with a late fee, and your credit score could be impacted.
When Is a Loan Considered to Be in Default?
What happens if you stop making payments on a loan altogether? Then you’ll likely be considered in default on the loan. Note that there’s no set amount of time when a loan is considered in default — a borrower may be one payment behind or they may have missed 10 in a row. It depends on the type of loan, the lender, and the loan agreement.
What Happens When You Default on a Personal Loan?
When you default on a personal loan, you’ll likely be charged late fees. But you may face other consequences, such as:
• Your credit may be damaged. Creditors may report payments that are more than 30 days late to the credit bureaus. The missing payments could end up on your credit reports and stay there for up to seven years. This could cause your credit scores to drop and may pose an issue the next time you apply for new credit.
• You may need to deal with debt collectors. If you fall far enough behind to be contacted by a debt collector, you may encounter aggressive behavior on the part of the collection agency. However, keep in mind that the Fair Debt Collection Practices Act limits just how far debt collectors can go in trying to recover a debt. If you feel a debt collector has gone too far, you can file a complaint with the Consumer Financial Protection Bureau (CFPB).
• You could be sued. A lender or collection agency may file suit against you if they believe you aren’t going to repay the money you owe on a personal loan. If the judgment goes against you, your wages could be garnished, or the court could place a lien on your property.
• Your cosigner may be impacted. If you have a cosigner or co-applicant on your personal loan, and you default on that loan, they could be impacted. For example, a debt collector could contact you and your cosigner about making payments. And if your credit score drops because of a default, theirs may drop, too.
If you’re facing a loan default, there are some things you can do now to help yourself. A good first step is to contact the lender, preferably before your next payment is due. Explain your situation to them, and find out if they can offer you any relief measures — for example, temporarily deferring loan payments.
You may also want to reach out to a credit counselor. They can work with you to create a budget that covers the essentials and frees up funds so you can pay down what you owe.
Depending on your situation, it may also be a good move to contact a lawyer. Having legal assistance is especially crucial if you’ve been served with a lawsuit.
Recommended: Better Money Management Tips
Types of Personal Loans
In general, there are two types of personal loans — secured and unsecured. Secured loans are backed by collateral, which is an asset of value owned by the loan applicant, such as a vehicle, real estate, or an investment account.
Unsecured personal loans are backed only by the borrower’s creditworthiness, with no asset attached to the loan. You might hear unsecured personal loans referred to as signature loans, good faith loans, or character loans. Typically, these are installment loans the borrower repays at a certain interest rate over a predetermined period of time.
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Personal Loan Uses
Acceptable uses of personal loan funds cover a wide range, including, but not limited to:
• Medical expenses not covered by health insurance
• Home renovation or repair projects
• Wedding expenses
While there are benefits to taking out a personal loan, it might not always be the right financial move for everyone. Personal loans offer a lot of flexibility, but they are still a form of debt, so it’s a good idea to weigh the pros and cons before signing a personal loan agreement.
💡 Quick Tip: With low interest rates compared to credit cards, a personal loan for credit card consolidation can substantially lower your payments.
If you’re able to pay off your personal loan early, that’s terrific. Doing so could help you save on interest over the life of the loan, provide more of a cushion in your monthly budget, lower your debt-to-income ratio, and alleviate debt-related stress.
However, before you pay off the balance, it’s a smart idea to calculate whether it’s a good financial decision or not. If your personal loan agreement includes a prepayment penalty that could take a bite out of any savings you might see on interest costs. Removing a history of regular payments on a loan too early can have a slight negative impact on your credit. Plus, the extra money might be put to better use in another financial tool.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
Is it good to repay a personal loan early?
Paying off a personal loan early can be a good financial decision, as long as any prepayment penalty charge doesn’t cost more than you might pay in interest.
If I pay off a personal loan early, do I pay less interest?
Paying off a personal loan early doesn’t affect the interest rate you’ve been paying up until that point. It would mean, however, that the total amount of interest you’d pay over the life of the loan would be less than anticipated.
Does paying off a personal loan early hurt your credit?
Because making regular, on-time payments on an installment loan such as a personal loan is a positive record on your credit report, removing that history early can have a slight negative affect on your credit.
What is the smartest way to pay off a loan?
There are a number of ways you can go about paying down debt. Two popular methods include the avalanche method (which focuses on making extra payments toward highest-interest rate debt first) and the snowball method (which calls for paying off the smallest debt first, the moving on the next largest debt, and so on).
Do you save money if you pay off loans early?
Paying off loans early could save borrowers money in interest. However, they may be hit with a prepayment penalty, which could negate those savings.
Are shorter or longer loans better?
It depends on your financial needs and goals. Generally speaking, borrowers with longer-term loans tend to pay more interest. By comparison, borrowers with shorter-term loans typically have lower interest costs but higher monthly payments.
How long can you stretch out a personal loan?
Lenders offer a range of loan term lengths, though generally speaking, most are between two and seven years.
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