You can pay off a personal loan early - but should you?
The answer isn't always straightforward. While eliminating debt can be a smart financial move, there are a few things to think about before making an early repayment:
Could you save money on interest?
Will your lender charge a prepayment penalty?
Could early payoff impact your credit score?
Paying off a loan early can reduce the total interest you pay - but it could also come with unexpected costs or a temporary dip in your credit score. Read on to better understand whether paying off your personal loan early is the right financial decision for you.
Step 1: Consider All Your Debts First
Before throwing extra money at your personal loan, take a step back and review your overall financial situation. Other types of debt, such as credit cards, student loans, and auto loans, may carry higher interest rates or offer better incentives for early repayment. Prioritizing high-interest debts first could be a smarter financial strategy.
Do you have higher-interest debt? Credit cards, for example, usually have much higher rates than personal loans - sometimes over 20%. Paying those off first could save you more money.
What about student loans? Federal student loans often come with built-in benefits like deferment or forgiveness programs, so early payoff might not be the best use of your money.
Emergency fund okay? Make sure you’re not sacrificing savings or leaving yourself vulnerable in case of unexpected expenses.
Early repayment is smart - but only when it doesn’t throw off your bigger financial plan.
Step 2: Review Your Loan Agreement for Potential Fees or Prepayment Penalties
Not all loans are created equal. Some lenders charge a prepayment penalty if you pay off your loan early. It’s a way for them to recover some of the interest they expected to earn.
In the case of a prepayment penalty, paying off a loan early does not benefit you because you will pay the same amount of money in the end, if not more. The amount of these penalties can be fixed or based on interest, but they are usually set as a percentage of the unpaid principal loan balance at the time of payoff.
Although paying a loan off early can save you interest, a prepayment penalty can mean early payments hurt you more than they help you.
Common Prepayment Penalties:
Fixed Fees: A flat fee applied regardless of when you pay off the loan.
Percentage of Balance: A penalty based on the remaining loan balance.
Interest-Based Fees: Some lenders charge an amount equal to a few months' worth of interest.
Other Common Names for Prepayment Penalties:
Early Payoff Fees
Loan Exit Fees
Early Termination Fees
Breakage Costs
Yield Maintenance Fees
Reinvestment Fees
Early Redemption Charges
To avoid any surprises, check your loan agreement or contact your lender before making an early payment.
Step 3: Consider How Paying Off Your Loan Affects Your Credit Score
Paying off a loan early seems like it would only help your credit - but it’s a bit more complicated.
Things That Impact Your Score:
Credit Utilization Rate: Credit utilization measures how much credit you're using compared to your available limit. While this primarily applies to credit cards, installment loans (like personal loans) also affect your overall credit mix. Closing a personal loan account by paying it off early can reduce your total available credit, potentially increasing your utilization rate and lowering your score.
Credit History Length: Closing an account - especially a long-standing loan - can reduce your average credit age. A shorter credit history may lower your credit score, particularly if you don’t have many other credit accounts.
Credit Mix and Payment History: A diverse mix of credit accounts (credit cards, mortgages, auto loans, and personal loans) can positively impact your credit score. Paying off a personal loan early may remove an active installment loan from your credit profile, potentially affecting this mix. However, if you have a solid history of on-time payments, the impact should be minimal.
Bottom line: Paying off early might cause a slight dip, but if your finances are in good shape overall, it’s usually not a big deal.
Step 4: Weigh the Financial Benefits and Drawbacks
Here’s what to keep in mind when deciding whether to pay off your loan early:
Benefits of Early Repayment
Save on total interest paid
Lower your debt-to-income ratio (which helps with future loan approvals)
Free up your monthly budget for savings or other goals
Reduce financial stress by eliminating one more payment
Feel accomplished - being debt-free is a big deal!
Possible Drawbacks
Prepayment penalties could wipe out any savings
A slight credit score dip from closing the account early
Less cash on hand - you don’t want to empty your emergency fund or savings
Missed opportunities elsewhere, like investing or higher-interest debt repayment
Making the Right Decision for Your Finances
Ultimately, the decision to pay off a loan early is yours to make and depends on your personal financial goals and current financial health. Think about what matters most to you right now:
Think Big Picture: Where Else Could the Money Go?
Even if you can afford to pay your loan off early, ask yourself:
Could this money earn more in a high-yield savings account or investment?
Are you contributing enough to retirement or saving for other long-term goals?
Do you have big expenses coming up—like car repairs or medical bills?
In some cases, sticking with your scheduled loan payments while keeping your money flexible may offer more long-term value.
Still Unsure? AMG Finance Can Help!
If you're uncertain about whether to pay off your personal loan early or apply for a new loan, AMG Finance is here to help.
Our team can walk you through your loan details
We’ll help you weigh the pros and cons
And we can even help you apply for a new loan if it makes sense for you
Find a local branch or give us a call to explore your best options.
