Is it Advisable to Repay Your Loan Early?

March 30, 2022
10:35 pm
by Yamna Zafar

Is it Advisable to Repay Your Loan Early? I recently discussed with a friend whether or not she ought to pay off her loan early. She was curious about the advantages of paying off her personal loan early, as she had just received approval for the line of credit.

The answer to this question depends on a number of variables, including the amount you owe on your personal loan, the interest rate you’re paying on it, when your term ends (and, consequently, when any prepayment penalties would become due), and any penalties you might incur if you unintentionally made an early payment. Theoretically, if all loans were created equally, paying off debt before it’s due would always be preferable to delaying repayment due to interest. But in reality, depending on your unique circumstances, even little variations in these factors could make one choice preferable to another. In order to determine whether it makes sense for you to pay off a personal loan early, let’s examine each aspect separately:

The Amount Of Your Loan's Interest

The portion of your loan that you must pay back to the lender as compensation for utilizing their funds is called the interest rate. Depending on whether you are only being charged once a year or on a monthly basis, this might either be a % or an annual rate. The more money you owe on your loan, the greater the interest rate will be.

APR (annual percentage rate) is not the most crucial consideration when deciding whether it is worthwhile to pay off a loan early; rather, your individual interest rate is. Although it may be tempting, avoid making the error of learning the APR and comparing it to other loans. Do not assume that something is better just because it is cheaper by 1%, for instance, if a 30-year mortgage has an 8% APR and another 30-year mortgage has a 7% APR. The same rule holds true if two loans have different APRs—just because one has a higher APR does not necessarily imply that its terms are worse than those provided by its rival.

Prepayment Penalties' Cost

Prepayment penalties are one of the main justifications for early loan payback. Unfortunately, lenders have the right to impose these penalties if you repay your loan early, and they are frequently very high (the typical penalty is close to 1% of the outstanding sum). There are ways to avoid paying these fees, though.

Determine the interest rate you are paying on your debt first in order to determine how much it will cost you to prepay your loan. If the terms are clearly specified in writing, this can be simple; if not, contact your bank to find out how much interest they charge on loans with balances comparable to yours.

Next, calculate the number of months before repayment would be due under normal circumstances. This number might not exactly correspond to when payments are due each year (for example, a 12-month personal loan may have ten monthly payments). Nevertheless, it provides us with a solid foundation from which to calculate costs later.

Finally, multiply the amount owed by the number of months left before payback is due under normal circumstances. Let’s imagine, for illustration purposes, that my personal loans have a $1,500 total and a 6% interest rate. I’m effectively making an extra payment every two weeks if I want them paid off in a month rather than in four.

Prepayment penalties can be made even with a significant payoff, but it is preferable to avoid them.

Prepayment penalties are recoverable with a sizable payoff, but you are best off avoiding them. The cause? When it comes to personal loans, paying off the debt too quickly will end up costing you more in interest over time than it would have otherwise.

The final conclusion is that paying off a loan early can be advantageous, but only if you have the money to do so and your loan’s interest rate isn’t excessive. Consider holding your loan until it’s due if you don’t have the money or are paying a high-interest rate.