Home Philatelic investment Should you repay your personal loan sooner?

Should you repay your personal loan sooner?



There are many reasons people take out a personal loan, including vacation expenses, wedding expenses, home renovations, and more.

Being in debt is stressful, and the punishment for defaulting on payments can come in the form of legal action, a drop in your credit rating, or large late fees. This is why it is crucial that you do everything in your power to pay off your debt as quickly as possible. You may have heard this pay off what you owe as soon as possible can help you save extra money in the long run which sometimes it does.

In general, the longer you get bogged down in paying off debt, the more interest you will pay over the life of the loan. Therefore, it makes sense to prepay your loan. However, there are a few things to consider before you finish your payments several months earlier.

It’s possible?

Yes, it is possible to prepay your loan, saving you a few months over your repayment period. However, note that some lenders may charge a prepayment penalty fee for early repayment of the loan.

These fees are either an amount that indicates how much the lender will lose in interest if you prepay the loan, or calculated as a percentage of what you have to pay on the personal loan. Also, keep in mind that the way the penalty is calculated varies from lender to lender.

Also, all penalties are usually included in your loan agreement. On that note, if you decide to pay off your personal loan before the end of the loan term, call your lender or check your loan documents to make sure you won’t be charged a prepayment penalty.

Will it affect your credit score?

When it comes to paying off your credit card debt, you are reducing the amount of debt compared to your credit limit. This means that your credit utilization rate is lowered; thus improving your credit score.

However, personal loans do not work the same as they are installment debts. On the flip side, credit card balances are revolving debt, which means you can borrow more money up to your maximum credit limit as you make payments. In addition, there is no fixed repayment period.

Note that installment debt requires you to repay what you owe in equal and regular amounts within a set repayment period. Once you have paid off the debt, the account is then closed.

When you repay a personal loan in advance, it will show a shorter account life on your credit report. Remember, the longer your credit history, the higher your credit score. That said, you can lower your average credit score and the length of your credit history if you prepay a personal loan. A low credit score can prevent you from finding a job, good financial products, or housing.

On top of that, when you pay off debt early, you will lose the ability to make timely payments. Note that the more on time you make your payments, the more it will help you increase your credit score.

Things to keep in mind

Here’s a rundown of things to keep in mind if you decide to prepay your personal loan.

  • Monthly expenses. Consider your monthly expenses first before deciding to pay off your debt in advance. It doesn’t make sense to prepay your loan if it hurts your living expenses.
  • Interest rate. Make sure you compare the interest rate on the loan you want to prepay against your other debts. In general, debts such as credit card balances often carry high rates. This means that it makes more sense to pay them off first. By paying off debts with the highest interest rate, you’ll save more on long-term interest charges.
  • Retirement fund. Saving for retirement is vitally important, regardless of your age. If possible, you should save money for your retirement and not withdraw money from this account. So don’t use your retirement money to prepay your personal loan; this could have serious tax consequences.
  • Emergency savings account. An emergency savings account is designed to help you pay for unforeseen expenses such as car problems or medical bills. Setting up an emergency savings account is something you should consider before you prepay your loan.

Final result

Is debt consolidation a good reason to take out a personal loan, or is urgency a good reason for a loan? Well, both reasons are logical for getting a personal loan. Personal loans can be an affordable and convenient way to pay a large expense.

Plus, when used responsibly, it can improve your credit history. However, it would be best to consider whether your situation would allow you to take advantage of a personal loan. Paying off the loan in advance can leave you in a situation where you’ll likely write off all the money you saved on interest, pay a prepayment penalty, and it can hurt your credit history.

Michael started Your Money Geek to make personal finance fun. He has worked in personal finance for over 20 years, helping families lower taxes, increase income, and save for retirement. Michael is passionate about personal finances, side activities and everything geeky.