Effective Strategies to Pay Off Your Personal Loan Early
If your budget is spread thin trying to keep up with bills, you might benefit from paying off a personal loan early. It might seem counterintuitive to pour more of your hard-earned income into paying off a loan. However, there are a lot of benefits you may not have considered. When you pay off a personal loan faster, you can save on interest, reduce monthly payments and even improve your credit score.
When paying off a personal loan early, you should have a strategy in mind and a plan for your payments. Once you decide on a time frame, you can start chipping away at your principal and interest. From making extra payments to refinancing, there are several tips for paying off a personal loan fast. Find out more about why this early payoff strategy is beneficial, how to do it effectively and how to avoid prepayment penalties along the way.
Why Paying Off a Personal Loan Early Can Be Beneficial
Aside from the obvious — no more monthly payments — there are other benefits to paying off a personal loan early. Once you pay off the loan, you’ll have more financial freedom, a (hopefully) better credit score and you’ll save on interest.
Interest Savings
Most personal loans use simple interest. That means the lender charges the same percentage of interest each month, but the actual interest dollar amount changes because your principal is shrinking. With larger personal loans, interest may be amortized, meaning you pay more interest up front.
Either way, making extra payments to the principal of your loan will lower your overall balance, decreasing the total cost of interest.
Financial Freedom
Getting back a chunk of your income by eliminating debt sooner is freeing, especially if you have a large monthly payment. When you pay off a personal loan faster, it may be daunting to allocate so many resources at first, but the reward is definitely sweet.
Let’s say you make $3,000 per month and have a monthly personal loan payment of $600. That’s 20% of your income! Just think of what you could do with an extra $600 every month. You could invest more into your retirement accounts, save up for a bucket list vacation or enjoy a fancy dinner every now and again.
Credit Score Improvement:
Another perk of paying off a personal loan early is your credit score will typically improve. Getting rid of a loan balance lowers your debt-to-income ratio, which improves your credit utilization. Having a better credit score can open doors to a lot of opportunities including insurance discounts, lower interest rates and better rental options.
Best Ways to Pay Off a Personal Loan Faster
When determining how to pay off a personal loan early, there are a few strategies that might help. Along with making extra payments, you can create a biweekly schedule, round up, use windfalls and refinance.
Make Extra Payments
Sometimes paying off a personal loan early is as simple as making extra payments when you can. It’s good to have a monthly goal in mind, but life happens, and sometimes an extra payment isn’t feasible. Just make sure your lender applies any extra payments toward your principal (not your interest). Even small payments can make a big difference over time.
Biweekly Payments
You can also work with your lender to start making biweekly payments to your personal loan instead of monthly payments. By making a payment every two weeks, you’ll end up making 26 payments throughout the year, because some months are longer than others. This amounts to one extra (monthly) payment each year, without making a huge dent in your budget.
Round Up Your Payments
One of our favorite tips to pay off a personal loan fast is to round up your monthly payments to the nearest $50 or $100. For example, if your lender requires you to pay $426 each month, you could tell them to actually take out $450 or $500 each month instead. This is a simple way to add more to the pot without stressing over huge additional payments.
Use Windfalls
We know the last thing you want to do with your tax refund is pay off a loan, but applying extra cash that comes your way to your principal can really help speed up the process. Work bonuses, holiday cash gifts, insurance refunds and other financial windfalls can be great opportunities for lump-sum payments.
Refinance to a Shorter Term
One of the best ways to pay off a personal loan quickly is through refinancing. If you can secure a lower interest rate over a shorter period of time, you can focus on paying off your loan balance fast. This option may not make sense if you don’t have the money for an origination fee or an increased monthly payment, but if you do, refinancing can be super helpful.
Avoiding Prepayment Penalties: What to Look For
Many providers have a prepayment penalty clause that actually charges you money for paying off a personal loan early. This is because when you eliminate your debt before the lender expects you to, they lose out on interest payments.
Check Your Loan Terms
Always be sure to review your loan agreement and closing documents to search for prepayment penalties. Some states have laws that ban this practice (including Alaska, New Mexico, Iowa, Maryland, Vermont and Virginia), but it’s still a good idea to double-check your estimate.
Negotiate with Lenders
If your loan does include a prepayment penalty, there’s a chance you can negotiate with your lender to waive fees or reduce them. When prepayment penalties are high, and you can’t convince your lender to forgo them, paying off your personal loan early may not be worth the hassle.
How Extra Payments Can Help Pay Off Your Loan Quickly
If you’re ready to make extra payments on a personal loan, don’t forget these tips.
Apply Payments Toward Principal
As mentioned above, always make sure to specify that any extra payments you make will be going toward your principal. The principal is the amount you borrowed initially, not including the cost of interest. If your extra payments go toward interest, you may not shave off any time in your loan repayment.
Calculate Savings
Want to know how fast you can pay off your loan, and how much you’ll really save in the process? Let’s take a look at an example.
If you have a $10,000 personal loan with 8% interest and a 5-year term, you will pay $2,165.84 in total interest. If you pay off that same loan in three years instead of five, you would only pay $1,281.09 in total interest. That’s almost $900 in savings!
As a general rule, you can figure out how much interest you’ll pay monthly by dividing your interest rate by the months remaining in your loan term, then multiplying that number by your loan’s current balance.
Interest Rate➗ Months in loan term x Balance = Monthly Interest.
When the number of months in this equation or the loan balance decreases, your monthly interest cost also decreases.
Tips to Stay Consistent and Manage Payments
Having a plan to pay off your personal loan faster is good, but consistency is another thing altogether. Here are some tips for staying on track.
Automate Payments
This might sound scary, but creating automatic payments is one of the best ways to pay off a personal loan quickly.
Track Progress
Whether you’re using an app, a friend or a whiteboard, find a way to track your progress that will keep you accountable and stay motivated.
Reevaluate Your Budget
Paying off a loan early won’t always go according to plan. If things start to feel tight, reevaluate your budget to give yourself some breathing room. Conversely, if you feel like you could be paying more, it’s worth reevaluating the budget for a faster payoff as well.
If you’re determined to pay off your personal loan faster, you can save a lot of money on interest, improve your credit score and find more financial freedom. Choosing a payment plan and sticking to it can be difficult, but the rewards are worth it.
