What Happens If You Pay Off a Personal Loan Early?

If you have taken out a personal loan and are planning on paying it off early, it can help you save money. This is because the longer your loan term is, the more you will end up paying in the form of interest.

But is it even possible to pay off your personal loan early? Turns out, many lenders let you pay off your loans early. But it has its own pros and cons. 

In this guide, we will find out what happens if you pay off a personal loan early and what is a prepayment penalty. We’ll also discuss the benefits and drawbacks of paying off your loan early. So read on.

What Happens If You Pay Off a Personal Loan Early?

If you have got your hands on some extra cash, you can pay off your personal loan early. But before you do that, it’s important to consider the pros and cons of paying off your personal loan early:

Pros of Paying Off Your Personal Loan Early

There are many pros of paying off your personal loans early. These include:

• Savings on interest
• Lower debt-to-income (DTI) ratio
• Financial independence
• Fewer monthly obligations
• Possible increase in credit score

Cons of Paying Off Your Personal Loan Early

Some cons of paying off your personal loans include: 

• Prepayment penalty
• Reduction in your credit mix
• No more tax deduction
• Reduced cash on hand

What Is a Prepayment Penalty?

Prepayment penalties are one of the biggest drawbacks of paying off your personal loan early. If you pay off your personal loan early, you will be charged a prepayment penalty by a lender. 

But what is a prepayment penalty anyway? It is a fee that lenders charge to prevent borrowers from paying off their loans early. 

This is because lenders make more money from interest if you pay off your loan over a long term. If you pay off your loan early, you will be depriving your lender of all of their interest earnings from the remaining months.

So lenders charge a prepayment penalty to discourage borrowers from paying off their loans early. However, not all borrowers are required to pay a prepayment penalty. But you should still ask your lender whether there would be a prepayment penalty before applying for a personal loan. 

Impact On Credit Score

Paying off your loan early can save you money in the longer run. But does it affect your credit score? Well, it has a very slight effect on your credit score. The more number of on-time monthly payments you have on your report, the better your credit score will be.

By paying off your personal loan early, you will be losing the chance to pay those monthly payments on time. What’s more, paying off your loan early will also result in a closed account on your report. Therefore, it won’t help your credit score and you may notice a temporary dip in your credit score.

Conclusion

Paying off your personal loan early can result in a slight dip in your credit score. However, it allows you to save on your monthly interest expenses and also lowers your DTI ratio. 

Now that you know what happens if you pay off a personal loan early, it is advised to do it if you can afford it. But do check with your personal loan provider about any prepayment penalties.

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