What happens if you pay off a personal loan early?

A general rule about debt is to pay it off as quickly as possible. We’ve talked lots about the subject, like in our 5 Steps to Help You Get out of Debt blog post. Most of the time, paying debt off early is a good idea as it means saving money on interest charges, like with credit card debt. But this rule doesn’t always apply.

Personal loans are sometimes an exception. Let’s talk about why, and when it’s a good (or bad) idea to pay off a personal loan early.

How are personal loans different from other debt?

There are so many financial products available now, and they’re all a little different. From loan rates to terms to interest rates and more, there’s a lot to consider.

Let’s say you need money to pay for something. Some loans are used to help pay for a specific thing, like a car or student loan or a mortgage.

Installment loans such as personal loans, on the other hand, offer you money to spend on almost anything from vacations to school supplies. You get a fixed amount of money as you agree to pay back monthly over a certain amount of time, plus the interest you agree to. You may have to say how you intend to spend the money on your application, but you aren’t usually required to stick to that.

Credit cards are different from personal loans because there’s no end date for repayment. You’re not paying in full over a certain term like with a personal loan. Of course, the faster you pay the money back, the less interest you pay. In a perfect world, pay off the whole balance each month and pay zero interest.

When to pay a loan off early?

If all these circumstances apply to you, it may be a good idea to pay off a personal loan early:

• There are no penalties for paying off your loan early. If your personal loan agreement says you don’t pay a fee to pay off your personal loan early, it may be a good idea to do so.
• You can weather a temporary drop in your credit score. If you aren’t planning any major purchases or financial moves, you can probably weather the temporary drop in your score. As long as you are making all payments on time, your credit score should bounce back.
• You have the money saved up to pay the loan off. If you have the money saved up to pay off your personal loan and you don’t need to pay off higher-interest debt first, it may be a good idea to pay off the personal loan early.
• You need/prefer to use the money for your monthly budget or investing. If you meet the above criteria and want to pay off your personal loan to free up funds in your monthly budget, paying off your loan early might be a good idea. It may also be a good idea if you meet the above criteria and you’d rather be able to use your loan payment amount from each month’s budget for savings or investments.

How does paying off a personal loan early affect your credit score?

Paying off a loan early may lower your credit score for multiple reasons.

First, your credit history is a major factor in your credit score. If closing an account early shortens the length of your credit history, it can lower your score.

Closing an account can also change the mix of your accounts, credit utilization, or your debt-to-income (DTI) ratio. These are significant to your credit score and can cause it to drop. You can learn more about credit scores from our blog post, 4 things that may improve your credit score.

Just remember, if you’re continuing to make all your payments on time, any drop in your credit score should potentially be temporary.

Pros of Paying Off Your Personal Loan Early

There are definitely valid reasons to pay off a personal loan early, such as:

• Saving money on interest
• Adding the payment amount back into your monthly budget
• Using the payment amount for higher-paying investing or savings instead
• Boosting your credit score if the early payoff improves your debt-to-income (DTI) ratio

Cons of Paying Off Your Personal Loan Early

There are also reasons not to pay off a personal loan early, such as:

• Having to pay early payoff penalties, where applicable
• Causing a drop in your credit score, potentially
• Shortening your credit history
• Having other debts at higher interest rates you could pay off first (see our blog post on getting rid of high-interest credit card debt)
• Paying off the loan means sacrificing your current budget or your emergency fund

Bottom Line

Personal loans may be a great way to build credit, pay for something over time, consolidate higher-interest debt or get quick cash – as long as you can afford the monthly payment. They can be a great option for an emergency home repair, a renovation project, or a vacation you haven’t totally saved up for, among other things.

Just be sure you understand the terms of your loan, including the interest rate, any fees, and whether there is a penalty for paying the loan off early. Selecting a loan that you’re able to pay off early may offer you important financial flexibility in the future.

FAQs: Paying a personal loan off early

Is there a penalty for paying off a 30-year loan early?

Every loan is different, so do your research. It will depend on the terms of your loan and your financial situation. You can check the documents you signed at the bank or contact the lender for more information about early payoff fees.

If you do want to pay off a 30-year loan early, research the pros and cons to understand your options. For example, directing extra payments to the principal of your loan will help you pay the loan off sooner.

How long after paying off a personal loan does a credit score improve?

Your score may or may not improve. It can often take several months for your credit score to rebound from an early loan repayment. Check out our blog post on how to improve your score for more information.

Can you pay a lump sum off a personal loan?

In most cases, the answer is yes. You just need to know if there are penalties for doing so and consider your options carefully. Know (or find out) the terms of your loan agreement and your options. It’s important to understand whether there are any early repayment or interest repayment conditions on your loan, and to be prepared for possible impact to your credit score.