You’ve just gotten a significant raise on your paycheck, and instead of splurging on a new item of clothing; you’ve decided to pay off your personal loan early while you have the means to. Before making this decision, keep in mind these do’s and don’ts to make sure it’s the best choice for you.
Read your loan Terms and Conditions
It’s crucial to fully understand your loan agreement, to know if your loan comes with any additional charges or prepayment fees.
Make sure you can handle extra fees
The main point that can affect your decision to pay off your loan early, is prepayment fees. These are extra charges that are issued by some lenders as you are clearing debt before you’re legally needed to. Early repayment penalties are approximately around 1-2 months of interest on top of the full loan amount that you are paying back. Use online calculators to determine how much you’re going to have to pay.
Improve your financial position
By paying your loans off early and in full, your financial status improves as you now have more money back into your wallet to spend on other needs or savings. It also improves your debt-to-income ratio as now your monthly debt payments are removed, giving you a better chance to be approved for a new loan. Your credit score rises too, as you’re getting rid of existing debt.
Peace of mind
Less debt = less stress. Keeping up with monthly debt repayments can be tedious and worrying if you have enough money, that month could be stressful. If paying your loan early will give you that peace of mind, make sure you understand everything it entails.
Use your savings or retirement
Avoid paying your debt early if you will have to use your savings or emergency funds. This will make it more difficult for you to pay for unexpected expenses. You might then have to find other ways to make back that funds, which could mean more work for you.
Less money in your pocket
Paying off your loan in full early reduces the money you can have in hand. Meaning you could enjoy fewer luxury items or not enough funds for other debts, as opposed to making the minimum monthly payment which you should have already budgeted for.
You won’t save on precomputed loans
If your prepayment fees are already part of your loan, then you might not save on paying early because of the extra costs. These extra costs could mean paying more than what you accounted for initially.
As to consider before settling a loan early
Before deciding to repay your loan off early, remember these few questions to make an informed decision.
- Do I know if my lender charges an early repayment fee?
Check your loan agreements for extra charges or prepayment penalties.
- How much could I save with early repayment?
To work out how much you might need to pay in additional fees, consult your financial advisor or use an online calculator.
- If I pay off a personal loan early, do I save interest?
Yes, the sooner you pay off your loan, the less you will pay in interest as interest accumulates over time.
- Will my decision positively or negatively affect my financial position?
Keep in mind the consequences of paying your loan early and how that will affect your situation now. Does your credit score need a boost, or should you stay away from using your savings right now?
No matter your choice, make sure you’re prepared for your decision!