Can You Pay Off a Personal Loan Early?

Personal loans are a popular financial tool that enables people like you to borrow money for a variety of purposes such as paying for a home remodel, consolidating debt, covering medical expenses, and paying for your child’s college tuition.

Typically, you pay off a personal loan in accordance with a predetermined repayment period. You may be wondering if it’s possible to pay off your personal loan early. Many of us are taught that it’s good practice to pay loans off as soon as possible so we can be relieved of debt. But when it comes to a personal loan, that is not always the case.

In this article, we will explore the topic of early loan repayment, look at the advantages of early loan repayments, as well as discuss the considerations involved, and finally provide useful tips to help you make an informed decision when it comes to a personal loan.

 

Advantages of Paying Off a Personal Loan Early

 

 Save Money on Interest

The quicker you’re able to pay off a loan, the less it will cost in interest. If you can pay off a personal loan early, it will lower your total cost of borrowing, potentially saving you a considerable amount of money.

For example, what if you’ve already repaid $10,000 on a $30,000 personal loan with an interest rate of 10 percent and three years left on your term? If you paid off the remaining $20,000 balance early in one lump sum, you would save approximately $6,000 in interest over the remaining term of the loan. 

 

Improved Credit Score

An early repayment can positively affect your credit score. Paying off your loan early demonstrates responsible financial behavior and may improve your credit utilization ratio, which is a factor that could bring about an increase in your credit score. A higher credit score will help you receive better loan terms and interest loan rates in the future.

 

More Money in Your Monthly Budget

If you’re able to pay off your loan early, you will no longer have to contend with a recurring payment on a monthly basis. That means you can apply those extra dollars to your daily living expenses. These monies will become invaluable when it comes to covering nettlesome expenses such as high utility bills and electrical repairs.

By paying off your personal loan early you’ve infused your monthly budget with some padding that will prevent you from having to scrounge around for extra funds when it comes to unexpected household maintenance costs.

 

Personal Freedom and Peace of Mind 

By paying off your entire personal loan early, it gives you the peace of mind of knowing that you are debt free. You’re rewarded with financial freedom. It also allows you to allocate your funds toward important financial goals like saving for retirement or launching a business or paying for a home improvement project. You can finally take that big family European vacation you’ve dreamed of for so many years.

 

Considerations For Paying Off Your Personal Loan Early 

There are some considerations, or even drawbacks, that you need to think about when it comes to paying off your personal loan early. For example, there is a chance that paying off your loan prematurely may negatively impact your credit score.

In general, paying off debt early is a good thing. But credit reporting agencies look at several factors when determining your credit scores. They look at factors like credit mix, payment history, and credit utilization. They can all be affected by paying off a personal loan early.

Credit Mix — Your credit mix is comprised of different types of loans you have. It could include personal loans, student loans, mortgages, and credit cards. A well-maintained credit mix demonstrates that you are a responsible credit user, and that can increase your credit score. But if you pay off your personal loan early, you could eliminate that loan type from your credit mix. This might reduce the diversity of your loans and decrease your scores.

 Payment History — Your payment history will display information about your credit account payments. This will include how many accounts you have paid on time and how long any late payments went unpaid. A personal loan can actually improve your credit score by building up a positive payment history. That is if you make payments on time. However, if you pay off the personal loan early, that means there will be fewer opportunities to make those on-time, in-full payments.

Credit Utilization — This is the available credit that you are using. That has a direct impact on your credit score. For example, say your credit cards and other loans have high outstanding balances, but your personal loan has a lower balance because you’ve been studiously making payments. This might equal out to an acceptably low credit utilization ratio.

It is worth noting that any decrease in your credit score will probably be temporary and small. And it will likely be worth balancing that risk against the potential benefits of paying off your personal loan early.

 

Additional Considerations

Reduce Your Debt-to-Income Ratio — The debt-to-income ratio measures how much debt you have compared to your income. Lenders will use your debt-to-income (DTI) ratio to determine whether or not – and at what rate – you can manage monthly payments. Paying off a personal loan might improve your DTI ratio.

While ratios will vary, the Consumer Financial Protection Bureau (CFPB) recommends that homeowners maintain their DTI ratio at 36 percent or less. For renters, the CFPB recommends a DTI ratio of 15 percent to 20 percent or less.

Avoid Prepayment Penalties — There are some lenders who will charge a fee if you pay off your personal loan before the term concludes. This is called a prepayment penalty. It is designed to protect the lender from losing revenue on interest.

Prior to paying off a personal loan early, you should thoroughly read the agreement or ask the lender about its prepayment terms. It may be possible to pay off the loan early without a prepayment penalty if you pay it off within certain parameters. For example, a lender could allow you to pay up to a certain percentage of the total balance annually before charging a fee.

In fact, some personal loans don’t have any prepayment penalties whatsoever.

 

4 Tips for Paying Off a Personal Loan Early 

1)     Communicate with Your Lender — It’s a good idea to regularly correspond with your lender and discuss your desire to pay off the personal loan early. Ask for clarity on prepayment penalties, if any, and verify the procedure for making additional payments. Certain lenders may have specific instructions or requirements for early loan repayment.

2)     Maintain Emergency Savings — While paying off your personal loan is an admirable goal, it is essential that you maintain an emergency fund. Unexpected expenses can occur, and having a financial safety net will prevent you from having to fall back into debt.

3)     Review Your Finances — Evaluate your financial situation to decide if paying off your personal loan early is feasible. Consider your income, expenses, and other financial obligations. Put together a budget to be sure you can comfortably make additional payments without putting undue pressure on your finances.

4)     Prioritize Additional Payments — If you’ve made the decision to make extra payments, prioritize them toward the principal amount instead of the interest. By decreasing the principal balance, you reduce the interest accrued over time, ultimately accelerating your loan payoff.

 

Look to California Community Credit Union for Personal Loans

 

At California Community Credit Union, we have the financial experts who can guide you through the entire process for your personal loan. You won’t have to stress at all as we help you choose the perfect personal loan that fits your unique circumstances and personal needs.

Look to CACCU as your professional partner when it comes to selecting the right personal loan for you. We offer low rates and flexible terms.

We invite you to contact us today to get started.