What happens if you pay off a personal loan early?

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When it comes to paying off debt, you may have heard that getting your balance back as quickly as possible can save you money in the long run. And that is often the case. For example, paying off your credit card balance in full will save you interest.

In general, the longer you are stuck with repaying a loan or other debt, the more interest you will pay over the life of the loan. So it goes without saying that repaying your personal loan early would be a good idea – but not that fast.

Below, Select explains why personal loans are different from other types of debt, and how early repayment can affect your creditworthiness and finances.

How are personal loans different from other debts?

There are plenty of financial products out there when you need cash to pay for something. And everyone is a little different, making it virtually impossible to have a one-size-fits-all approach to debt settlement. You should consider things like interest rates, billing cycles, repayment terms, and fees when creating your plan.

Student loans are used to pay tuition fees and other costs associated with an education. Car loans are meant to help you purchase a vehicle. Personal loans can be used for pretty much anything – a wedding, a home renovation, a vacation, and even a debt consolidation. While you may need to explain how you plan to use the money on your application, there is generally no hard and fast rule about how to use your personal loan.

As with a car loan or a student loan, you receive a lump sum that you have to repay in monthly installments over a set period of time (the so-called loan term) along with the interest.

The repayment period for a personal loan can be between two and five years, some even up to seven years. Auto loans generally have an average maturity of six years, while student loans usually have a ten-year term, but it could take longer if you have an income-driven repayment plan.

Personal loans are different from credit cards in that there is no set time frame for paying back your credit card debt. The faster you pay the remaining balance, the less interest you will incur. (Ideally, you should pay off your balance on time each month and never pay interest.) Credit cards also have a credit limit, which is usually much less than the average personal loan amount borrowers charge.

While the personal loan interest rate is generally much lower than that of credit cards, it really depends on how much money you are asking for and what your credit rating is. Remember that the higher your creditworthiness, the more favorable your terms can be. A good credit score will help you get a lower interest rate or a longer repayment term, or both.

Sometimes personal loans come with some additional fees, including a commitment fee and an early repayment penalty. It is the early withdrawal fee that you need to be careful about.

Is it possible to repay a personal loan early?

It is possible to pay off your personal loan early, but you may not want to. Making an additional payment each month, or using some or all of the cash gain on your loans, could help you cut your repayment deadline by a few months. However, some lenders may charge a prepayment penalty for early repayment of the loan.

The prepayment penalty can be calculated as a percentage of your loan balance or as an amount that reflects how much the lender would lose in interest if you paid back the balance before the loan term expired. The calculation method varies from lender to lender, but any prepayment penalties will be listed on your loan agreement.

There are a number of lenders who do not charge early repayment penalties. For example, SoFi does not charge you a prepayment fee for early repayment of the loan, nor are there any commitment fees or late payment fees. If you’d rather find a peer-to-peer lender, LendingClub is another option for no prepayment fee loans. Typically, you need good to excellent credit to qualify for the best personal loans on the best terms.

SoFi personal loans

  • Annual percentage (APR)

    5.99% to 18.85% when you sign up for Autopay

  • Loan purpose

    Debt Consolidation / Refinancing, Home Improvement, Relocation Help, or Medical Expenses

  • Loan amounts

  • conditions

  • Credit needed

  • Origination fee

  • Early withdrawal penalty

  • Late fee

How does early repayment on a personal loan affect your creditworthiness?

When you settle your credit card balance, you decrease your credit card debt in proportion to your total credit limit. This means that your usage rate, which is 30% of your creditworthiness, will be lowered and you can increase your creditworthiness a little. Shouldn’t it be the same with repaying your personal loan?

According to Experian, personal loans don’t work the same way because they’re installment debt. Credit card debt, on the other hand, is revolving debt, which means there is no set repayment deadline and you can borrow more money up to your credit limit while making payments. The installment debt is a form of credit in which you have to repay the amount in regular, equal amounts within a specified period of time. When you finish repaying the loan, the account will be closed.

When you take out a personal loan, you increase the number of open accounts on your credit report. The loan can also improve your credit mix which is 10% of your FICO score. But when you pay off an installment loan, it appears as a closed account on your credit report. Closed accounts are not weighted as heavily in calculating your FICO score as open accounts. So once you’ve paid off your personal loan, you’ll have fewer open accounts on your credit report.

If you pay off the personal loan earlier than your loan term, your credit report will reflect a shorter account term. Your credit history represents 15% of your FICO score and is calculated as the average age of all your accounts. In general, the longer your credit history, the better your creditworthiness. So paying off a personal loan early can lower your average credit history and lower your credit score. How much your credit score changes depends on your overall credit profile.

Low credit can put you at a disadvantage, making it difficult to find a home, good financial products, or even a job. However, if you practice good financial habits, e.g. For example, making consistent, timely payments and not applying for too many new lines of credit at the same time can improve your score.

Bottom line

Personal loans can be a convenient and inexpensive way to cover large expenses and improve your credit score if used responsibly. But, as with any financial instrument, you should carefully consider whether your circumstances will allow you to get the most benefit from a personal loan. Repaying the loan early can put you in a situation where you will have to pay an early repayment penalty, which could potentially reverse any monies you would save in interest, and it could also affect your credit history.

If you feel that you might want to repay the loan sooner than the terms require, you should apply to a lender who does not charge an early repayment penalty. Always do some research and read the terms and conditions before signing up for a new financial product so you know exactly what to expect.

Note to editors: Opinions, analyzes, reviews or recommendations expressed in this article are solely those of the Select editorial team and have not been reviewed, approved or otherwise endorsed by third parties.

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