What to Know About Paying Off Personal Loans Early

Q: Is it a good idea to repay a personal loan early?

Paying off a personal loan early may be right for you depending on your personal circumstances. However, if your lender charges a prepayment penalty, it could eat away at the interest savings.

Q: Does paying off a personal loan early hurt credit?

By reducing your “credit mix” and shortening your history of on-time payments on the loan, early payoff could have a slightly negative impact on your credit profile. But paying off a personal loan on time may also have a negative impact on your credit in the short term.

What to Know About Paying Off Personal Loans Early

Sulaiman Abdur-RahmanUpdated June 25, 2023

Share this article:

Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

If you have a personal loan, you may wonder whether you can pay it off early, and if doing so means you will pay less interest. The answer to both of those questions is yes. However, that doesn’t necessarily mean paying off your loan ahead of schedule is a good idea.Personal loans sometimes come with prepayment penalties, which could eat away at any savings in interest. Here’s everything you need to know about early payoff of a personal loan.

Understanding Personal Loans

If you need funding, personal loans can provide you with a lump sum of money to be repaid over a set term as closed-end credit. Personal loans may have repayment terms ranging from 12 months to seven years, and some lenders may offer longer loan terms.Can you pay off a personal loan early? Yes, you can pay off personal loan debt early. Paying off your personal loan early may minimize your interest costs, but some personal loans may include a prepayment penalty personal loan clause.

Definition and Purpose of Personal Loans

By definition, personal loans provide borrowers with funding that can be used for personal, family, or household purposes. The borrower receives a lump sum of money and agrees to repay the debt over a set term. The terms and conditions of a personal loan may include interest charges and origination fees.The difference between personal loans and other loans is that personal loans have few restrictions on their use. Student loans, for example, must be used for education purposes. Other examples of closed-end credit — including mortgage loans and auto loans — have clear limitations on their use.Personal loans give the borrower a lump sum of money — not revolving credit — that can be used for a variety of purposes.Lenders may offer online personal loans up to $100K, and borrowers may use the funds to finance large purchases or consolidate debt.

Loan Terms and Conditions

A personal loan agreement may include certain terms and conditions, such as the annual percentage rate (APR), term length, and the potential consequences of a default. The consequences of defaulting on a loan can be severe. Lenders may sue you for breach of contract, and your credit score may plunge if you fail to make required payments on a personal loan.The terms and conditions of a personal loan agreement may also include a prepayment penalty personal loan clause. You may minimize your interest costs and improve your debt-to-income ratio when you pay off personal loan debt early, but prepayment penalties can add up if your loan charges prepayment fees.Prepayment penalties generally have to be disclosed in your loan agreement. It can be helpful to review the terms and conditions of a personal loan offer before accepting and signing the agreement.

Can You Pay Off a Personal Loan Early?

Borrowers may pay off a personal loan at any time. (Borrowers facing financial hardship may request deferred payment loan relief.) However, depending on your lender, early payoff may come with a cost. While some lenders won’t charge any fees for paying off your loan ahead of schedule, others may charge a prepayment penalty.Lenders may calculate the prepayment penalty as a percentage of your outstanding loan balance. It might start out around 2% and then decline each year of the loan until it reaches zero. This set-up allows the lender to recoup any interest lost as a result of early repayment of the loan balance. The calculation method will vary from lender to lender, but any prepayment penalties would be outlined in your loan agreement.

Exploring Early Loan Repayment Options

Borrowers may pay off a personal loan before the designated repayment period ends. For example, a borrower with a 60-month repayment term may consider paying off the loan in less than 60 months. Paying off a personal loan early may minimize your interest costs.

Prepayment Penalties

Some lenders may charge prepayment penalties if you pay off a loan early. As mentioned earlier, prepayment penalties generally have to be disclosed in your loan agreement. It can be helpful to review the terms and conditions of a personal loan offer before accepting and signing the agreement.

Definition and Purpose of Prepayment Penalties

A prepayment penalty is a fee that lenders may charge if you pay off a loan early. Personal loan lenders typically charge interest, but borrowers may minimize those interest charges by paying off the loan early. That’s why some lenders may charge prepayment penalties to recoup any interest lost as a result of early repayment of the loan balance.Borrowers may have less of an incentive to prepay their loan if there’s a prepayment penalty risk. If your lender charges a prepayment fee, you’ll want to do the math and compare what you’ll save in interest vs. what you’ll pay in prepayment fees.

Checking for Prepayment Penalties

Lenders generally have to disclose financing terms and conditions when offering consumer loans, including the existence of any prepayment penalties. Prepayment penalties would be outlined in your loan agreement, and you may decline a loan offer if you’re unhappy with the proposed terms and conditions.You may contact your lender for clarification if you’re unsure about any terms of the loan agreement. The Truth in Lending Act generally prohibits lenders from engaging in unfair or deceptive consumer lending practices.

How to Pay Off a Personal Loan Early

Below we highlight how you may pay off a personal loan early:

Assessing Your Financial Situation

You may evaluate your financial standing and consider whether early loan repayment is feasible and right for you. Budgeting and financial planning may guide you in the decision-making process if you’re interested in minimizing your interest costs.Recommended: What Is Budgeting and How Can You Start?

Strategies for Early Loan Repayment

Here are some ways of paying your loan off early:

1. Increasing Monthly Payments

Increasing monthly payments can accelerate loan repayment and reduce interest costs. For example, you may consider making extra payments toward loan principal each month. This can promote early loan repayment and minimize your total interest charges.

2. Making Lump Sum Payments

Making occasional lump sum payments toward loan principal in addition to your regular monthly payments can promote early loan repayment. Any extra funds you receive — such as bonus compensation, merit pay, or a tax refund — can go toward paying down your loan balance.

3. Refinancing the Loan

Refinancing your loan for a lower interest rate and shorter repayment term can give you a path toward early loan repayment. In terms of ways to refinance a personal loan, you can borrow a new loan to pay off an existing loan in your name. Getting a lower interest rate and shorter repayment term can reduce your interest costs and allow you to pay off the debt sooner.

The Takeaway

Paying off a personal loan early can minimize your interest costs and improve your debt-to-income ratio. Some lenders may charge a prepayment penalty to recoup any interest lost as a result of early repayment of the loan balance. Other lenders may advertise their personal loan products as having no prepayment penalties.If you need a personal loan without a prepayment penalty clause, Lantern by SoFi can help. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice.Compare personal loan rates and apply in minutes.

Frequently Asked Questions

Is it a good idea to repay a personal loan early?

Does paying off a personal loan early hurt credit?

Is it cheaper to pay off a personal loan early?

Photo credit: iStock/VioletaStoimenova

LCPL0623003

About the Author

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and served as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.

Share this article: