Pay off a personal loan early

If you've found extra money in your budget to pay off your loan early, congratulations! Being financially secure enough to consider this step is a win in and of itself. Paying off a loan early could save you money and quickly free up your budget so you can focus on other financial goals.

What a personal loan is: A personal loan is a lump sum of money that you borrow from a bank or other financial institution, which you can use to cover a range of personal financial needs. It’s unsecured, which means you don’t need to put up collateral, or something of value you own that backs up the loan.

Paying off a personal loan before it’s due isn’t always to your advantage. For one thing, some lenders charge a prepayment penalty. This fee might make early payments unattractive. Instead, the better move might be putting extra money toward credit card debt or an emergency fund.

You may have also heard that paying off your loan early hurts your credit score, and this could be true in some cases. Your credit score could possibly drop a bit, but the pros could easily outweigh this potential drawback.

We’ll take a look at the different aspects of early loan payoff, including the pros and cons, and how to decide whether it's the right move for you.

Can you pay off a personal loan early?

Yes, you can usually pay off a loan early. Most lenders have no problem with you making extra payments to get rid of your loan faster.

Some lenders do charge a prepayment penalty. Sometimes, you’re only penalized if you pay during an early part of your loan. Lenders have different prepayment penalty rules. Some apply only to full payoff, while others can be triggered by any early loan principal payments. 

The easiest way to check is to call your lender and ask. You should also be able to find prepayment details on your loan documents. (If you’re reading the documents online or in an electronic format, use the search function to find specific phrases.)

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. Fewer loan payments means fewer interest payments, so your overall loan becomes cheaper. 

Another perk: you get rid of the debt faster. The sooner you free yourself from debt, the sooner you can put money toward other endeavors. Extra payments don’t reduce how much you owe monthly, but they do make your loan go away faster.

Plus, less debt lowers your debt-to-income ratio (DTI). A lower DTI helps you get better terms for future credit. It signals to lenders that you can pay off debt without too much trouble. 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. It’s one less thing to manage. No more tracking payments and hoping you didn’t miss something. That’s something worth celebrating.

Will paying off a personal loan early hurt my credit?

It could, but the impact is generally temporary. Paying off a loan early could ding your credit score if it’s your only installment loan because it changes your credit mix—a small part of your credit score (10%). Contrary to popular myth, however, your account age won’t be affected at payoff. Accounts closed in good standing stay on your credit report for up to 10 years.

The potential credit ding is pretty well offset by the perks, in most cases. Lower debt is typically a plus. A lower DTI may help you qualify for a better house, among other things. Frankly, “to support my credit mix” is not a good reason to keep a loan open and pay extra interest fees if you don't have to. 

How to pay off a loan early

You can pay off a loan early in four ways:

1. Make extra payments

2. Switch to biweekly payments

3. Make a lump-sum payment

4. Refinance to a lower rate

Extra payments

Make regular monthly payments, plus extra 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 stay consistent. If you stick to a predictable two-week schedule, it’s less effort to stay on track. You could 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 set this up directly with your lender, as it may not be automatic. That way, you could ensure your lender applies the extra payments to the principal.

The easier you make this habit, the more likely you’ll stay on track. 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 owe overall.

You might use a lump sum to pay off the remainder of a loan if you're nearing the end. But putting it toward a younger loan could still help you pay it off early and save money on interest.

Say you owe $8,000 on a loan with a four-year term and a 16% APR. Here’s how much a lump-sum payment could save you on interest if you make the extra payment early in the loan term.

Refinance

If you refinance to a lower interest rate, you could reduce how much interest you owe 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. The extra money going to your principal could help you pay off the loan faster and for less. It’s easy to budget because you’re simply paying the same as before.

Cons of paying off a personal loan early

Your lender might charge a prepayment penalty, typically a percentage of your remaining loan at the time of payoff. Lenders do this to recoup the cost of the interest you would have paid. Ask your lender whether they charge a prepayment penalty. A large penalty could make prepayment unattractive.

Another drawback: paying extra so you can pay off a personal loan early cuts into money you have to spend elsewhere. Perhaps you want to build an emergency fund or pay down a high-interest credit card debt first.  Early pay off means you have less available cash for those goals.

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

How to decide if early loan payoff is right for you

Paying off a personal loan early could save you money in interest and free up room in your budget. Check for prepayment penalties, and make sure early payoff won’t leave you short on savings. If those boxes are checked, early payoff could be a smart move.

Go through the following checklist:

• 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 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? Paying down credit card debt first could save you more money and immediately improve your credit score. 

• 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.