Can You Pay Off Loans Early?

Paying off a personal loan early could save you thousands of dollars in interest payments. But can you actually pay off loans early? Or will doing so damage your credit and incur costly penalties?

This guide will answer those questions and more. Read on to learn about the pros and cons of paying off loans early, and for tips on how to do it.

Is it possible to pay off loans early?

Yes, it’s usually possible to pay off loans early. However, doing so may not always be the smartest financial decision. Your calculations should look at whether your loan contract has a penalty for prepayment. These penalties may be as high as 1% to 2% of your total loan balance, although the percentage often decreases the longer the loan has been active.

The best personal loans tend not to have penalties for prepaying. But an aggressive payday loan might. If you’re unsure about your loan, it’s best to review your contract, which will typically be available through the online account you use to pay your bill.

The pros of paying off loans early

Paying off a loan early can have both positive and negative consequences for your finances. Here are the benefits of paying off your loan early.

You’ll save on interest

You may be able to save a substantial amount of money by paying off some loans before they’re due. You can use an online loan payoff calculator to determine how much you would save.

You'll improve your debt-to-income ratio (DTI)

Paying off a loan reduces your total debt balance, which improves your debt-to-income ratio (DTI). This can increase your credit score and may make it easier to get approved for future loans.

You’ll have more to spend in your monthly budget

Without that loan payment to worry about, you’ll have more space in your budget to spend on the other important parts of life, such as utility bills, rent and groceries.

The cons of paying off loans early

Remember that paying off your loan early can have some drawbacks.

You may be charged prepayment penalties

These may be large enough to reduce some of the savings you’re expecting on interest by paying off your loan early.

Your credit score could take a hit

There are some scenarios in which paying off a loan early could bring your score down. Learn more about this in the next section.

There may be better uses for the money

If you have other types of debt with higher interest rates, you could potentially save more on interest by paying off those loans first with your extra cash. You could also invest the money you spend on paying off the loan early.

Things to know about paying off loans early

If you’ve evaluated the pros and cons and are still interested in paying off a loan early, your next step should be to identify your prepayment penalty and understand how the decision will impact your credit. Here’s why.

Prepayment penalty

Your prepayment penalty will play a large role in determining whether or not it’s worth it to pay off a loan early. If you must pay 2% of the loan balance to close the account early, the amount that you save by doing so may not be the best way to use that sum of money.

Even some of the best emergency loans can have high interest rates. But if you have an emergency loan with a large prepayment penalty, you may end up not saving as much as you think by paying it off early — even if your interest rate is quite high.

Credit score impact

Paying off a loan early can have a complicated impact on your credit score. Doing so will reduce your debt-to-income ratio which, under normal circumstances, would improve your score.

However, your credit score is also impacted by:

• On-time payment history
• The average age of your credit accounts
• Your mix of credit accounts (having a diversity of credit account types is usually better for your score than having only one type of loan, all other things being equal)

By paying off those auto loans or unsecured business loans early, you may lower your average credit age and eliminate a major account from your credit mix. You also miss out on an opportunity to build a positive credit history by making consistent on-time payments over a longer time frame.

Any credit score dip that you may experience by paying off a loan early should be weighed against the benefits of doing so. It’s difficult to predict how much your credit score would potentially decline, and you may be able to repair the damage by taking additional actions.

6 tips for paying off loans early

Paying off your loans early can add space to your monthly budget and improve your overall financial health. If you’re interested in doing so, here are several tips for making it happen.

Create a budget

The first step you should take is to create a budget that shows you how much you can allocate monthly toward paying off your loan balance early. This will let you know how soon you may be able to pay off the loan in question and whether additional steps may be necessary to meet your goals.

To create an accurate budget, take the following steps:

1. Write down your total monthly income.
2. Add up all of your monthly expenses.
3. Subtract your monthly expenses from your monthly income.
4. Any leftover amount is the total possible extra contribution you could make toward paying off a loan early.

If you perform these calculations and are unhappy with how long it will take to pay off your loan, you can look for ways to reduce your expenses and bring in more income.

This may mean spending less on entertainment, looking for bargains at the grocery store or starting a side hustle to bring in more money. Another way to save money is to examine your monthly subscriptions, such as streaming services.

Pay more than the minimum

If you want to pay a loan off before the projected date in your contract, then you’ll have to pay more than the minimum amount. For some types of loans, such as credit cards, paying more than the minimum amount will help you avoid incurring extra interest on top of what you already owe.

One thing to keep in mind is that you can still pay off a loan early even if don't pay more than the minimum every month. For example, you could pay extra when you get overtime hours at work or when your expenses throughout the month are lower than usual.

Make two payments every month

Paying more than your minimum amount due can help you make progress toward an earlier pay off date. But if you want to accelerate that progress, consider making two payments every month instead of one.

If you pay the total amount due twice every month instead of once, you could have your loan paid off twice as fast (or close to it). If you get paid twice monthly, you could allocate the same percentage of each paycheck toward the loan to keep things simple.

Look into refinancing options

As you consider the best way to approach your loan, refinancing is another option worth looking into — especially if the debt in question is a home or auto loan. Refinancing can be used as an alternative to paying off the loan early or as part of your strategy for doing so.

Typically, refinancing involves taking out a new loan with better terms than your existing loan. That may look something like this:

Imagine you have a car loan for $20,000 at 9% interest.

If your credit has improved since you took out that loan, you may be able to borrow the $20,000 you need to pay it off from another company at a lower interest rate.

By borrowing the $20,000 at 5% instead of 9%, you’ll save a significant amount on interest and could bring your monthly payment down.

Refinancing isn’t always a realistic option. Your ability to find loans with better interest rates will often be tied to the rates set by the federal reserve. This means better rates may not always be available when you’re interested in refinancing. Plus, you may need better credit to qualify for a refinanced loan than you had when you took the initial loan out.

If you’re interested in refinancing, check in with the company that currently handles your loan. If they aren’t able to help you, then you can look up alternative options online. It will be easier to find a good refinancing opportunity with good credit, but you can also review the best loans for bad credit to see if any of those options could work for you.

Consider debt consolidation

Debt consolidation is similar to refinancing. However, it’s a term that’s more commonly associated with lumping together multiple existing debts under a single loan with a larger balance rather than simply getting better terms for one existing loan.

For example, if you have credit card debt through multiple companies, debt consolidation would involve taking out a larger loan to pay off each of those credit cards so that you only have to make a single payment moving forward.

The best debt consolidation loans will lower your interest rate and simplify your life by giving you one lower payment to make rather than several higher ones. However, to qualify for debt consolidation, you generally need a good credit score, so this strategy may not work for everyone.

Start a side hustle

Paying off a loan early harder to do when you don’t have the extra income for it. But you can still make it happen by embracing a new side hustle. It’s never been easier to make money on your own, and you may be able to raise the funds to pay off a loan early.

For example, you could try one of the following ideas:

• Pursue app-based income. Whether you drive for Uber or Lyft; shop for people on Instacart; or deliver food through DoorDash and Uber Eats, you can start earning more money quickly by signing up for app-based earning opportunities.
• Start an online store. If you have creative ability, you may be able to market and sell products through Etsy and similar artisanal platforms.
• Become a freelancer. Upwork, Fiverr and other freelancing websites have thousands of clients looking for freelance experts in a variety of fields. Whether you’re a great writer or a creative video editor, you may be able to put those skills to work by creating a profile on one of these sites.
• Rent your spare space. Do you have a spare room in your home? You could list the space on a site like Airbnb to start bringing in more income with little additional work.
• Work as an online tutor. Plenty of websites connect aspiring learners with tutors who are experts in those fields. Maybe you’re a native speaker of a non-English language. Or perhaps you’re a math whizz. Online tutoring will allow you to leverage those skills to earn extra income without having to leave your home to do so.
• Leverage your social media following. Even if you only have a few thousand followers, you may still be able to get deals with brands who want to market their products to your audience. You can charge flat rate fees or earn a percentage of every product your audience purchases.

With a side hustle, you can pay off loans early even if there’s no room in your current budget for doing so. Everyone is an expert in something. With so many income-earning opportunities available online, you should be able to earn a profit in your area of expertise to help you pay off your car loan early or make faster progress as you work to pay off your student loans.

Summary of Can You Pay Off Loans Early?

It’s almost always possible to pay off personal loans early. But when deciding whether that’s the right decision for you, it’s important to consider both the pros and cons of doing so.

Paying off your loans early can reduce interest payments and free up space in your budget. However, you may incur a prepayment penalty by making this decision which could negatively impact your credit score. You may also want to consider refinancing the loan or pursuing debt consolidation if you have several loans you’d like to pay off early.