Is it smart to pay off your personal loan early?

The finish line for your personal loan is nearly in sight, and you’re thinking about picking up the pace. If you start paying extra, you could rid yourself of debt ahead of schedule, and that’s always exciting. Practically anyone would be happy about having one less bill to pay.

Paying off a personal loan early can be a smart move, but it’s not for everybody. The right decision depends on your situation. With a little knowledge about early loan payoffs, you’ll be ready to decide how quickly you should pay back your personal loan.

The upside of paying off a personal loan early

Part of how personal loans work is that you pay interest on your loan every month. One of the biggest upsides to an early loan payoff is that you could save on those interest charges. If you pay off your personal loan three months early, that's three months' worth of interest you don't need to pay.

Early payoff could also make managing money easier. You’ll simplify your finances with one less bill to pay, and you’ll free up more money for your budget. You can redirect the money that was going to loan payments toward another goal, such as building an emergency fund or contributing to a 401(k).

If you’re planning to apply for any new loans or credit cards, an early loan payoff can potentially help with that, too. Lenders typically look at your debt-to-income (DTI) ratio during the application process. Your DTI ratio is your monthly debt payments divided by your pre-tax income. Many lenders consider 35% or less to be a good DTI ratio. You can find yours using our DTI calculator.

For example, imagine you have $2,000 in monthly debt payments and make $5,000 per month before taxes. 

Here’s your DTI ratio:

$2,000 / $5,000 = 0.40

0.40 x 100 = 40%

In this example, your DTI ratio would be a little on the high side. But if you decide to pay off a personal loan early, cutting a $300 payment from your monthly bills, your DTI would drop to 34%. This could improve your ability to get new credit.

When it’s better to not pay off a loan early

It’s better not to pay off a loan early if it’s going to hurt your finances in other areas. For example, it’s usually not a good idea to dip into emergency savings for an early loan payoff. An unforeseen expense can strike at any time, and your emergency fund provides you with a safety net and peace of mind.

Be careful not to put your future at risk, either. If paying off your personal loan means skipping retirement contributions, you may be better off making the usual monthly payments.

Some personal loans charge prepayment penalties for early payoffs. The extra fees could end up costing you more than the money you save. Before you start paying extra, check if your loan has a prepayment penalty. If so, find out the details. Many prepayment penalties only kick in with substantial early payments. 

An early loan payoff is a luxury. If you can manage it without any negative side effects, then go for it. If it will cause issues elsewhere or strain your finances, there’s nothing wrong with following your loan’s original payoff schedule.

Questions to ask before you pay off your personal loan early

Here are a few smart questions to ask yourself if you’re thinking about paying off a personal loan early:

• Does my personal loan have a prepayment penalty? If so, your best option may be to follow the regular payment schedule.

• Is this my highest-interest debt? If you have accounts with higher interest rates, such as credit card debt, prioritize those debts to save more money.

• Do I have enough in my emergency fund? A rule of thumb is to have at least three months of expenses saved.

• Will this lead to financial strain? If you’ll need to work large amounts of overtime or follow an extremely strict budget, you may want to save yourself the stress. 

If early payoff isn’t realistic

You have plenty of alternatives that could speed up your progress on your loan. For a simple option, figure out if you can make one extra payment per year. You’ll still pay off your personal loan more quickly, without needing to make a huge jump in how much you’re paying.

If your goal is to save on interest, another option is refinancing your loan. You get a new loan with a lower interest rate and use it to pay off your original loan. Refinancing could be a good move if you’ve made all your loan payments on time and your credit score has increased since you first got a loan.

If you have multiple debts, you could look into debt consolidation loans to simplify your finances and potentially get a lower rate. With debt consolidation, you get a new loan and use it to pay off multiple accounts. After that, you only need to make a single monthly payment on your debt consolidation loan. Check out our guide on how debt consolidation loans work to learn more.

What’s next: finding your balance

You’re already in a good position. You know you’re going to pay off your personal loan—it’s just a matter of when. The goal isn’t just to be debt-free fast, but to be debt-free and on financially solid footing.

Consider what kind of loan payment fits your budget and financial goals, while keeping your peace of mind. If you’d like more help, learn more about personal loans and what payoff timeline works for you.