When does prepaying a personal loan make sense?

When you’re in a financial crisis, a personal loan can quickly provide you with the cash you need. But these types of loans are not a panacea: they generally carry high interest rates. One way to reduce interest charges is to prepay your loan.

Accelerated gain can have major advantages and serious disadvantages. A thorough understanding of your loan terms and financial situation can help you decide if it makes sense to pay off a personal loan sooner than expected.

[Read: Best Personal Loans.]

Can you repay a personal loan early?

Generally, you can prepay a personal loan regardless of who issued it.

“I can’t think of a scenario I’ve seen where you can’t pay off a personal loan sooner,” says credit expert Gerri Detweiler.

But that doesn’t mean that paying off a loan early is always a good idea. For example, some personal loans have prepayment penalties. If you prepay a personal loan, you may have to pay a fee for the privilege of doing so.

Check to see if your lender charges a prepayment penalty.

“Most personal loans don’t incur a prepayment penalty,” says Detweiler. “If that’s the case with your loan, you’ll save money by paying it off faster.”

What are the benefits of prepaying a personal loan?

The biggest benefit of expediting loan repayment is that it can save you money.

“In many cases, paying off a personal loan early will save the borrower money in interest,” says Thomas Nitzsche, financial educator at Money Management International, a nonprofit credit counseling agency. lucrative.

With loan payments on the sidelines, you free up cash to fulfill your monthly budget. You may have more funds to direct to another financial goal, such as investing, saving for a deposit or just having more “fun money,” says Nitzsche.

high borrowers debt to income ratios will find that paying off personal loans early can reduce theirs, “perhaps increasing their chances of being approved for another loan,” he says.

You can also expect emotional rewards. “Repaying a loan is a huge emotional relief for many consumers, especially if the loan was related to past trauma or associated with a difficult or negative time in their lives,” says Nitzsche.

You won’t have to worry about future payments, adds Detweiler, or what to do if your life circumstances change.

“If your income goes down or other expenses go up, you won’t have to worry about whether you can cover the payments,” she says. “Being debt-free, or closer to it, can mean peace of mind.”

[Read: Best Debt Consolidation Loans.]

What are the disadvantages of prepaying a personal loan?

Paying off personal loan debt early has a few drawbacks: namely, you may have less cash in the short term.

“If the savings are used to repay the loan, it can create a shortage in the borrower’s emergency fund,” Nitzsche said. “Especially if the borrower is experiencing career uncertainty, it may be best to keep the loan and continue to make payments on time.”

Indeed, losing cash by investing money in a loan can be dangerous in certain situations, recognizes Detweiler.

“If you’ve invested every extra penny in debt, you may find that you haven’t saved money for unexpected expenses,” she says. “A financial emergency could result in the need to take out another loan.”

Another downside to putting extra money into a personal loan is that you might be able to earn a better rate by investing the funds instead, Nitzsche says.

Additionally, your personal loan may come with a prepayment penalty for repaying all or part of the loan sooner than expected. Ask your lender about these fees before proceeding to avoid surprises.

How does prepaying a personal loan affect your credit?

It may be tempting to pay off your loan early in hopes of boosting your score, but that’s not how it works. The impact depends on what else is in your credit report.

“You may find it drops a bit, especially if you don’t have other active installment loans — like a mortgage or car loan — reporting to your credit reports,” Detweiler says.

Once you have repaid a personal loan, your credit report will show that the loan is closed. This differs from a credit card, which remains open even after paying off a balance. FICO weighs open accounts more heavily than closed accounts when calculating your score, which means paying off a personal loan is unlikely to help your credit rating.

[Read: Best Debt Settlement Companies.]

The do’s and don’ts of paying off your personal loan early

Before prepaying a personal loan, keep these do’s and don’ts in mind.

To do:

Study your potential savings. “Use an online calculator to figure out how much you’ll save with various prepayments,” says Detweiler.

Make sure you have a emergency fund. That should be enough to cover three to six months of living expenses before you think about paying off your loan early. “In some cases, it might make sense to repay a little less aggressively to make sure you’re still saving for emergencies,” Detweiler says.

Look carefully at the conditions and fees. Find out if your lender charges a prepayment penalty and how it compares to the long-term interest charges of the loan.

Not :

Ignore other financial goals. Consider whether it makes more sense to pay off or pay off another line of credit, such as a credit card or car loan.

Neglecting a payment plan. If you decide to go ahead, determine how quickly you want to pay off the personal loan. Some borrowers may want to repay their loan quickly. “The savings you see can motivate you to find ways to free up extra money to pay off the loan faster,” says Detweiler.

On the other hand, others could benefit from a more gradual approach. “Putting the loan on automatic payment at a rounded payment amount or making payments every two weeks when you get paid — instead of monthly — are easy ways to pay off the loan early,” says Nitzsche.

Neglect to balancewants and needs. “Create a plan to pay off your debt as quickly as possible without completely sacrificing your savings goals,” says Detweiler.

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