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Paying a personal loan off early can make sense in certain circumstances. Read on to learn when it’s worth doing.
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Personal loans can be a great way to borrow money. With a personal loan, you have flexibility regarding what you do with the funds the lender provides to you. You can usually use the money for just about anything.
Unlike credit cards, personal loans can come with pretty affordable rates. While the average rate on a 24-month personal loan was 11.48% as of February 2023, this average has dropped below 10.00% numerous times in the recent past. And, personal loans also have set payoff schedules — such as a 24 or 48 month loan — so there’s no surprises about when you’ll be debt free.
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Despite these benefits, there’s no question that personal loans can be a financial burden. If you have one, you will be losing money to interest charges and have a monthly obligation that eats up your income. As a result, you may wonder whether it makes sense to get ahead on personal loans and pay more than required to become debt free sooner.
To decide whether that makes sense for you, there are a few key questions to ask yourself.
1. How much money will you save?
The first thing to think about is just how much early payoff is going to save you. Say, for example, you borrowed $10,000 on a 48-month loan with an 11.48% interest rate and $260.79 monthly payments, and you had 36 months remaining on your loan. You might opt to pay an extra $100 per month on top of the $260.79 you were already paying on the loan.
If you make these extra payments to get ahead on paying off your personal loan, you would become debt free 11 months faster and would pay a total of $2,051 in interest instead of the $2,516 that you’d have paid if you didn’t get ahead.
Saving so much money is a major advantage — especially since personal loan interest isn’t tax deductible, unlike mortgage loan interest (which you can usually deduct if you itemize).
The amount you save may make early payoff worth it — especially if the interest rate on a personal loan is above 10.00%, which is the average annual return (before inflation) the S&P 500 provides. If your rate is higher, then you can likely get a better return on investment with early personal loan payoff than by putting your money into the stock market.
2. Are there prepayment penalties?
When deciding if you should get ahead on paying off your personal loan, you do need to consider whether you’ll get hit with penalties. Many lenders promise you won’t be charged if you pay off your loan early — but that’s not the case in every situation.
If you are charged a prepayment penalty, this could negate the savings from early payoff so it would no longer be worth it. Check your loan paperwork to see if this is an issue for you and, if so, see how your penalty stacks up to the interest you’d save.
3. What other kinds of debt do you have?
Finally, before you decide to get ahead on your personal loan, check to see if there’s any other debts you should be paying off first. If you have credit cards or other loans at a higher interest rate, it makes sense to pay off your costlier debt first as you’ll save more on interest.
By asking yourself these three questions, you can decide if getting ahead on personal loan payments is the right move or if there’s something else you should be doing to better improve your net worth over the long run.
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