A general rule about debt is to pay it off as quickly as possible. We’ve talked lots about the subject, like in our 5 Steps to Help You Get out of Debt blog post. Most of the time, paying debt off early is a good idea as it means saving money on interest charges, like with credit card debt. But this rule doesn’t always apply.
Personal loans are sometimes an exception. Let’s talk about why, and when it’s a good (or bad) idea to pay off a personal loan early.
There are so many financial products available now, and they’re all a little different. From loan rates to terms to interest rates and more, there’s a lot to consider.
Let’s say you need money to pay for something. Some loans are used to help pay for a specific thing, like a car or student loan or a mortgage.
Installment loans such as personal loans, on the other hand, offer you money to spend on almost anything from vacations to school supplies. You get a fixed amount of money as you agree to pay back monthly over a certain amount of time, plus the interest you agree to. You may have to say how you intend to spend the money on your application, but you aren’t usually required to stick to that.
Credit cards are different from personal loans because there’s no end date for repayment. You’re not paying in full over a certain term like with a personal loan. Of course, the faster you pay the money back, the less interest you pay. In a perfect world, pay off the whole balance each month and pay zero interest.
If all these circumstances apply to you, it may be a good idea to pay off a personal loan early:
Paying off a loan early may lower your credit score for multiple reasons.
First, your credit history is a major factor in your credit score. If closing an account early shortens the length of your credit history, it can lower your score.
Closing an account can also change the mix of your accounts, credit utilization, or your debt-to-income (DTI) ratio. These are significant to your credit score and can cause it to drop. You can learn more about credit scores from our blog post, 4 things that may improve your credit score.
Just remember, if you’re continuing to make all your payments on time, any drop in your credit score should potentially be temporary.
There are definitely valid reasons to pay off a personal loan early, such as:
There are also reasons not to pay off a personal loan early, such as:
Personal loans may be a great way to build credit, pay for something over time, consolidate higher-interest debt or get quick cash – as long as you can afford the monthly payment. They can be a great option for an emergency home repair, a renovation project, or a vacation you haven’t totally saved up for, among other things.
Just be sure you understand the terms of your loan, including the interest rate, any fees, and whether there is a penalty for paying the loan off early. Selecting a loan that you’re able to pay off early may offer you important financial flexibility in the future.
Every loan is different, so do your research. It will depend on the terms of your loan and your financial situation. You can check the documents you signed at the bank or contact the lender for more information about early payoff fees.
If you do want to pay off a 30-year loan early, research the pros and cons to understand your options. For example, directing extra payments to the principal of your loan will help you pay the loan off sooner.
Your score may or may not improve. It can often take several months for your credit score to rebound from an early loan repayment. Check out our blog post on how to improve your score for more information.
In most cases, the answer is yes. You just need to know if there are penalties for doing so and consider your options carefully. Know (or find out) the terms of your loan agreement and your options. It’s important to understand whether there are any early repayment or interest repayment conditions on your loan, and to be prepared for possible impact to your credit score.
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