Early repayment of a personal loan may temporarily hurt your credit, but it’s important to consider the long-term advantages of paying off a personal loan ahead of time. Below, we’ll discuss just a few.Pros Of Paying Off A Personal Loan Early
You Can Save On Interest
If your interest rate or annual percentage rate (APR) is high, you’ll pay a lot more to borrow money. That’s why paying off a personal loan early often makes financial sense – the sooner you pay it off, the less you’ll pay in interest.
Let’s say you get a personal loan for $5,000 with a 3-year term at an interest rate of 5.95%. If you take a full 3 years to pay off that loan, you’ll pay slightly more than $471 in interest. If you took that same loan and paid it off in 2 years, you’d pay about $315 in interest, saving yourself around $156 in the process.
The figures get higher, of course, if you borrow more money at a higher interest rate and for a longer term. Let’s say you take out a $10,000 personal loan at an interest rate of 7% with a 5-year repayment term. You’d pay about $1,880 in interest if you took the full 5 years to pay that loan back. If you instead paid that loan back in 3 years, you’d pay only about $1,115 in interest – a significant difference in savings.
You Can Lower Your DTI
Your debt-to-income ratio (DTI) is the amount of your income that goes toward your monthly debt payments. Paying off a personal loan early can lower that ratio, and having a lower DTI can make you eligible for a better interest rate on other loans.
You Can Increase Your Budget
A month-to-month budget plan can help ensure you have the money to afford all your monthly payments and day-to-day expenses. Freeing up the money that would normally go toward your personal loan can give your monthly savings or budget a boost. You could also put that extra money toward other debts, invest it or save for retirement.
Cons Of Paying Off A Personal Loan Early
Saving money on interest is a smart financial move, but this doesn’t mean that everyone who can pay off their personal loans early should do it. For some people, this isn’t the best decision. Consider the following reasons to hold onto your extra money rather than making extra payments on your personal loan.
You Have Other Debts To Consider
If you owe a significant amount on credit cards or other high-interest loans, it might make more sense to pay off those debts first.
A personal loan with an interest rate of 7% will cost you less than $4,000 worth of credit card debt at an interest rate of 20%, so it’s best to pay the more expensive debt off before worrying about your personal loans.
If you have a mortgage, auto loan, or both, be sure to always have enough money set aside for them, since missed payments on these loans can cost you your home and vehicle, respectively.
You Want To Build An Emergency Fund
If you don’t have an emergency fund, that’s another instance where it’s best to skip paying off your personal loan early. Instead, take your extra cash to build an emergency fund.
An emergency fund, as its name suggests, is a pool of money you only dip into to cover unexpected expenses. This way, you won’t have to accrue credit card debt paying for emergency medical bills or car repairs.
Most financial experts say you should have 3 – 6 months of daily living expenses saved in your emergency fund. If you don’t have this, building that fund might be better than paying off your personal loan.
You Could Invest The Extra Money
You might be able to make money by investing the dollars you’d spend on paying off your personal loan. Of course, this all depends on your loan’s interest rate.
You could invest your money in the stock market and earn a return percentage on your dollars. That might be a good move if your personal loan’s interest rate is lower than your potential return.
