Pay off a personal loan early

So you've found extra money in your budget and you're wondering: Can you pay off your personal loan early? Yes, you usually can, and it could save you money on interest while you get out of debt faster.

The bigger question is whether you should pay off your loan early. Will the savings outweigh any potential drawbacks?

A personal loan is a one-time sum you borrow from a bank or other financial institution. As installment loans, personal loans are paid off according to a set schedule, but you typically have the option of paying yours off early. Just because you can doesn't mean it's always the best move, however.

Some lenders charge a prepayment penalty, which is a fee for paying off a loan early. That could add to the total cost of paying off the loan. You might have smarter places to use that extra money, such as putting it toward credit card debt or an emergency fund.

Can you pay off a personal loan early?

Yes, you can usually pay off a personal loan early. Most lenders are fine with extra payments that help you clear your balance faster.

Loans that carry a prepayment penalty are an exception. These penalties differ by lender. Sometimes a penalty applies only during an early part of your loan. Some lenders charge only for a full payoff, while others may assess a penalty on any early payment.

Your loan contract should spell out if there's a penalty, including when it applies and how much it costs. A penalty could take different forms, such as:

• Flat fee: A fixed dollar amount for settling the balance ahead of schedule.

• Percentage of the balance: A share of the principal you still owe as of the early payment date.

• Months of interest: A charge equal to a few months worth of the interest you would have paid on the normal repayment schedule.

To find if your loan has a prepayment penalty and what that penalty consists of, search your agreement for terms such as "prepayment fee" or "early payoff." In most cases, you should find that there is no penalty for paying a personal loan off early.

Pros of paying off a personal loan early

The top benefit of paying off a personal loan early is that you typically pay less total interest. The faster you pay down your loan balance, the less interest you'll pay.

Another perk: You get out of debt faster. The sooner you free yourself from debt, the sooner you can put money toward other goals. Extra payments don't reduce how much you have to pay monthly, but they could reduce the number of payments you'll have to make over the life of the loan.

Plus, less debt lowers your debt-to-income ratio (DTI). A lower DTI may help you get better terms for future credit and lets lenders know you can handle debt. DTI can be an important factor when applying for a loan. For example, most borrowers need a DTI of 43% or less to qualify for an FHA loan (mortgage). You can calculate your DTI with a debt-to-income ratio calculator.

Your stress levels may also drop. A paid-off loan gives you one less thing to manage. No more tracking payments and hoping you don't miss something. That's worth celebrating.

Will paying off a personal loan early hurt my credit?

An early payoff could affect your credit score, though the impact is generally temporary. An early payoff could ding your score if it's your only installment loan, because that changes your credit mix. Credit mix is a small part of your FICO credit score (10%).

Contrary to popular myth, your account age won't be affected at payoff. Accounts closed in good standing stay on your credit report for up to 10 years.

Overall, an early payoff usually won't lift your score on its own, and it could cause a small dip. Things that tend to support your credit include a steady on-time payment history and low credit card balances.

The potential for a slight credit ding is pretty well offset by the perks in most cases. Less debt is typically a plus. It should save you money, plus a lower DTI may help you qualify for a mortgage or car loan, and to get cheaper credit terms generally. Compared to those benefits, keeping a loan active just to maintain your credit mix is probably not worth it.

Achieve is not a Credit Repair Organization and does not provide, or offer, services or advice to repair, modify, or improve your credit.

How to pay off a loan early

You can pay off a loan early in four ways:

• Make extra payments

• Switch to biweekly payments

• Make a lump-sum payment

• Refinance to a new loan

Extra payments

Make your regular monthly payments, plus pay an extra amount whenever you have the cash. It could be an extra $20 one month and $200 the next. You should specify to your lender that you want this extra money to go toward your loan principal. This is the most flexible option, because you control when and how much you pay.

Say you have a $10,000, five-year debt with a 15% APR and monthly payments of $238. You decide to pay more each month. Here's how much money you could save on interest:

Biweekly payments

Switch to biweekly payments to pay off your loan faster while keeping payment amounts consistent. A predictable two-week schedule can be easier to keep track of than occasional extra payments. You could even set it up so you make a payment with each paycheck if you get paid biweekly.

To make biweekly payments, split your monthly payment in half and pay it every two weeks. You may have to arrange this directly with your lender to make sure they apply the extra payments to the principal. This may not happen automatically.

Biweekly payments result in 26 half-payments each year, which equals 13 full monthly payments over a year. In other words, an extra monthly payment each year.

Lump-sum payment

Make a lump-sum payment to put a windfall to work. An inheritance, annual tax refund, or similar could be put toward your loan principal all at once. The sooner you pay down your principal, the less interest you'll pay overall.

You might use a lump sum to pay off the remainder of a loan if you're nearing the end. But even using lump sums to pay part of the balance on a younger loan should still help you pay it off earlier and save money on interest.

Say you owe $8,000 on a loan with four years left to go and a 16% APR. Here's how much a lump-sum payment could save you on interest at that point:

Refinance loan

When you refinance, you pay off your old loan with a new one. If you refinance to a lower interest rate, you could reduce how much interest you'll pay without making a single extra payment. You might even combine a refinance with an early payoff strategy.

For example, if you refinance a $10,000 loan from a 17% to 13% APR, you might continue making the same monthly payments you had with the higher APR. More of those payments would now go toward principal instead of interest. This could help you pay off the loan faster and for less. It's easy to budget for because you're simply paying the same amount as before.

Achieve Personal Loans have fixed rates and no prepayment penalties, so you can pay ahead any time without an extra fee.

How to get your payoff amount

Once you're ready to pay off your loan, here are a few steps to help things go smoothly:

• Request your payoff amount. Call your lender or log in online, and ask what it would cost to pay off your loan now. Confirm when the quote expires, which is often within about a month. Your payoff amount is the remaining principal plus any interest accrued since your last monthly payment, so it could be a bit higher than just the principal left.

• Confirm there's no prepayment penalty. Check your loan agreement or ask your lender before you send a large payment, so a fee doesn't hit you by surprise.

• Direct the extra money. Tell your lender to apply anything above your regular payment to the principal.

• Get written confirmation. Ask your lender for written proof it closed the account and cleared the balance, then check your credit report to confirm.

Cons of paying off a personal loan early

Early payoff has a lot of benefits, but it could have some downsides to consider, too.

For one, your lender might charge a prepayment penalty. This is typically a percentage of your remaining loan at the time of payoff. Lenders do this to recoup the interest you would have paid. A large penalty could make prepayment unattractive.

Another drawback: Paying off a personal loan early means that money can't be spent elsewhere. Perhaps you want to build an emergency fund or pay down a high-interest credit card debt first. Early loan payoff means you'd have less available cash for those goals.

Early payoff could also ding your credit score slightly. This is typically temporary and not worth sweating in most cases. Lenders care more about your overall finances than your credit mix specifically.

How to decide if early loan payoff is right for you

Not sure whether to pay off your loan early or use the money for something else? Here's what to consider before deciding:

• Would you owe prepayment penalties? Call your lender or check your loan documents. Even if you would owe a penalty, you should still run the numbers. The penalty could cost less than potential interest savings.

• Do you have emergency savings? If not, you might want to build up a cash cushion for your peace of mind before paying down a loan that you're managing well.

• Do you owe higher-interest debt? Pay down high-interest credit card debt first to potentially save more money.

• Does early payoff strain your budget? Leave a margin for error, room to recover if things don't work out perfectly. Life happens, and this is you planning for it.

Take it slow and think through your choices. The thing to understand is why you're paying off a loan early (or not), so you can make your decision with confidence.

Need a new personal loan? Find out if you qualify through Achieve Personal Loans.