Paying off a personal loan early: What you need to know

Paying off a personal loan early may sound ideal. You’ll have one less debt to worry about, and you could allocate those funds toward another debt. However, it’s not that simple, and paying off a loan early may have consequences. 

Learn more about some of the potential advantages and disadvantages to paying a loan off early.

A prepayment penalty on a personal loan is a fee charged when borrowers complete the loan payoff before the agreed-upon end of the repayment term. Wells Fargo personal loans have no origination fees or prepayment penalties, meaning you can pay off your balance early at any time without incurring extra fees. If your loan is with another lender, check your original loan agreement or contact customer service to verify whether early-payoff fees apply.

In most cases, you can pay off a personal loan early. However, some lenders charge a prepayment penalty, or they may have a required time period for you to carry the loan before you can pay off the balance. 

It’s important to check the loan terms to confirm if there’s a prepayment fee. If there is, you can check to see how it compares to what you could save in interest by paying early.

Paying off a personal loan early can help you save money because you’ll pay less interest and free up some cash flow. The key is to find the right balance where these payments do not cause financial stress in other areas of your budget.

The biggest advantage of paying off a loan early is that you pay less interest. On simple interest loans, interest is charged each month on the remaining principal balance. If you accelerate your payoff by paying more each month, it will reduce both the total months in repayment and the total amount of interest charged.

When budgets are tight, eliminating a fixed monthly bill can provide relief and flexibility. It can also give you a psychological win to know that you successfully paid off an installment loan, and did it early.

Once your personal loan is paid in full, consider redirecting those former monthly payments toward other financial priorities. Some options include increasing your emergency fund and retirement savings contributions.

Paying off a personal loan early sounds like a positive thing, but there may be consequences.

If you spend too much on paying down the loan early, you could put yourself in a risky position. This may cause you to rely on credit cards or other types of borrowing in the case of an emergency expense.

Some debt costs more than others. If you carry balances on credit cards, for example, you may pay a higher Annual Percentage Rate (APR) on the credit card debt than on a personal loan. In those situations, it may make more financial sense to pay down the higher-interest debts first.

Some personal loans have prepayment penalties. If you plan to pay your loan off early, check the terms and conditions to see if they include any early payment fees.

A personal loan is a type of credit product, so it is factored into your credit score. You may see score fluctuations when you apply for and open the loan, during the repayment phase, and when you pay off the balance. 

Paying off a loan early could result in a temporary, small drop in credit score since it changes your “credit mix,” which is one of the factors considered by credit scoring algorithms. Credit scores look favorably at customers who manage different types of credit, including revolving lines like credit cards and installment loans like personal loans. If you complete a loan payoff and no longer have an installment product open, you may see that reflected in your credit score. 

On the other hand, if you make on-time payments throughout your loan term, you may see an incremental, positive change to your credit score. Additionally, paying down loan balances reduces your debt-to-income (DTI) ratio, the percentage of your gross monthly income dedicated to debt payments. While DTI does not directly affect credit scores, a lower DTI ratio improves your overall financial standing and may help you qualify for future borrowing, such as a mortgage or auto loan.

Paying off a loan early means your balance is zeroed out before the loan’s official end date. Here are some ways to close out the balance and potentially save money on interest. 

• Pay more than the minimum amount due. With an installment loan, you have a fixed payment throughout the loan term that you must pay each month. Let’s say you have to pay $250 per month for 24 months. If you increase your monthly payment to $325 per month, you will pay the loan off sooner and with reduced interest charges. 
• Make extra payments. If you have extra room in your budget, you could make additional payments on your personal loan. Remember to indicate to the financial institution that you want to use the extra payment toward the principal. You may need to speak with customer service to do this. 
• Make a lump sum payment before the end of the loan term. If you happen to come into a large sum of money and decide you want to pay off your personal loan, start by asking the lender for the “payoff amount.” The amount fluctuates each day due to daily interest. Once you know the exact amount, you can submit the payment. 

If you’re aiming to pay off a personal loan early, the key is to find a happy medium where you can pay more than the minimum amount due on your personal loan but not so much that you have no margin of error left in your budget.

One deciding factor for paying off your personal loan early is to see how much it could save you. There are calculators online that can show you how various payment amounts and timelines can impact your overall loan cost. 

You can also do the math on your own by taking the total interest paid under your original loan schedule and subtracting the total interest you would pay under an accelerated payment plan. If there are any prepayment fees, subtract them from the interest savings.

Whether you should pay your personal loan off early depends on your financial situation. If you make bigger loan payments to remove a few months from your loan term, it may be a positive for your finances. However, making large payments that stretch your budget to its limits or deplete your savings could leave you with less of a financial cushion. 

Other factors to weigh include the early prepayment penalty and whether you have other debt with high interest that could be worth paying down first.