How To Pay off a Personal Loan Early: 6 Steps

Paying off a loan early has many benefits, like helping you save money on interest and improving your debt-to-income ratio so you’re in a better place to borrow money. While this decision should always be weighed carefully, if you’re wondering how to pay off a loan early, here’s a look at the steps you can consider to make it happen.

How to pay off a loan early

1. Check if you have a prepayment penalty

As the name suggests, a prepayment penalty is a fee charged by a lender if you pay off your loan early. Fortunately, these days, not many lenders charge a prepayment penalty on personal loans. They’re more commonly found in business loans, auto loans, and non-qualifying mortgage loans.

That said, it’s a good idea to read the fine print of your personal loan agreement in order to determine if you’ll be subject to an early payoff fee, and if so, how much it will cost. You can also contact your lender directly to find out this information. The answer you’re given may impact your decision to pay your loan off early.

2. Consider switching to biweekly payments

If your lender doesn’t charge prepayment penalties and you do decide that you want to pay off your loan early, one way to do that is by switching to biweekly payments instead of monthly payments.

To do this, simply pay half of your monthly payment amount every two weeks, making sure to pay both halves before the due date. Doing so will likely allow less interest to accrue since your payments will be applied more often. It will also mean you’re making 26 payments in a year, which translates to one extra full loan payment annually and will help you pay down your loan balance faster.

3. Make extra payments whenever possible

Next, whenever you have access to excess funds, consider using that money to make extra payments toward your personal loan. As discussed above, applying extra payments to your principal balance will help you become debt-free quicker and allow you to save on interest charges.

If you want to see how much you stand to save, using our personal loan calculator is a great place to start. However, as an example, if you take out a $10,000 personal loan at a 7% interest rate and make $200 monthly payments, you could pay off your loan in as little as 60 months. However, if you made just one lump sum payment of $1,000 on the loan, you could pay off the loan seven months earlier and save $387 in interest.

With that in mind, if you find yourself with an unexpected windfall, such as a work bonus, tax return or inheritance, think about putting that money toward your debts.

4. Adjust your budget to cut expenses

If you’re looking to generate extra money to put toward your debts, one suggestion is to adjust your monthly budget to cut expenses.

When budgeting, it can be helpful to look for both big and small ways to save money. For example, if you think you’re overextending yourself on your housing or car payment, you could think about looking into more affordable alternatives.

However, you can also aim to save on smaller expenses, such as:

• Looking for coupons or promo codes before you make a purchase
• Eating out less and cooking more
• Canceling unused subscription services
• Switching your phone plan to a more affordable option
• Sourcing free entertainment, such as outdoor concerts or hikes

5. Bring in extra income

Once you’ve looked at your budget and found ways to trim some excess, it’s a good idea to think about ways to generate extra income and use it to pay off your loan balance.

When thinking about ways to generate extra cash, it’s smart to start with your current place of employment. If you’re a salaried worker, think about asking for a raise or throwing your hat in the ring for a promotion. On the other hand, if you’re hourly, you could consider asking for more hours or working overtime.

Then, brainstorm ways you can bring in some added money on the side, including:

• Driving for a car service, like Lyft or Uber
• Making deliveries for a delivery service, like UberEats or DoorDash
• Starting a side hustle like freelance writing or selling crafts on Etsy
• Selling unused items

6. Think about refinancing your loan

Finally, another way to potentially pay off a loan early is by refinancing your debt. Refinancing allows you to take out a new loan, ideally one with a better interest rate and more favorable loan terms, and use it to replace your old one. You can refinance a single personal loan or combine multiple ones into a debt consolidation loan.

In this case, refinancing into a shorter loan term will help you pay off your loan more quickly. Alternatively, if you can secure a lower interest rate, it can lower your monthly payments, which may make it easier to put extra money toward your loan balance.

However, refinancing may not always be an ideal choice. If you can’t secure a lower interest rate or nearing the end of your loan term, you may be better off keeping your original loan and simply making extra payments whenever you can — especially when you also factor in the costs of closing on a new loan.

Pros and cons of paying off a loan early

Now that you know how to pay off a loan early, the next step is to decide whether this financial move is right for you. Here are some pros and cons to consider as you weigh your options.

Pros of paying off a loan early

There are many benefits to learning how to pay a loan off early, including:

 You’ll save money on interest

The biggest benefit of paying off a loan early is that you’ll save money on interest. To get a better sense of how this works, consider the following example:

Let’s say you have a $20,000 personal loan that has an 8% interest rate and a $350 monthly payment. If you stick to the payment schedule as prescribed, you will pay back the loan in 73 payments and pay a total of $5,261.59 in interest over the life of the loan.

However, if you apply an extra $50 per month toward your principal balance, you will repay the loan 62 payments and pay just $4,408.94 in interest, saving a total of $852.65.

 You’ll improve your debt-to-income ratio

At the same time, you’ll also improve your debt-to-income ratio (DTI). Put simply, your DTI is a measure of how much you earn versus how much you routinely spend on debt payments. Lenders use this metric when determining loan approval because it tells them whether or not a borrower can reasonably afford to take on more debt.

Your DTI is calculated by taking your gross monthly income and dividing it by the sum of your monthly recurring debts. Generally, a ratio of 43% or lower is considered good enough to be approved for borrowing.

Paying off your loan early will help improve your DTI because there will be one less monthly payment to include in the debt portion of your ratio. Since your DTI ratio is most often considered when making big purchases, like taking out a mortgage, it can be a good idea to work on your ratio if you’re thinking about buying a house in the near future.

 You’ll (eventually) have one less payment to consider

In the long run, paying off your loan early will likely put you one step closer to living a debt-free lifestyle. Getting out of debt can give you the breathing space you need to focus on other financial goals.

If you have the resources to do so, it may be worth some temporary penny-pinching in the short term in order to create a financial situation that better suits your long-term goals.

Cons of paying off a loan early

That said, like any financial decision, paying off a loan early does come with some considerations. Here’s what you need to know.

 You may face extra fees

While prepayment fees aren’t very common in today’s financial landscape, the cost can add up if there is one embedded in your loan agreement.

For example, if you’re subject to a 2% prepayment penalty on a $50,000 personal loan, you could end up paying $1,000 for the privilege of paying off your loan before its final due date.

You’ll have to weigh whether paying that fee is worth the benefits of paying your loan off early.

 You can temporarily ding your credit score

Believe it or not, your credit score can drop after paying off debt. This is due to a number of factors, including the fact that your credit utilization ratio and credit mix will be altered once you close out your personal loan account.

This drop in your credit report is often temporary. By keeping up smart financial habits, you’ll have a chance to build your credit score back up and maybe even surpass where it was before.

 You’ll (temporarily) have less money to put toward other expenses

At the end of the day, paying your loan off early will take some extra money out of your pocket. This means you’ll have less disposable income for other expenses, like your housing costs, student loans or contributions to retirement savings, like a 401(k) account.

As a rule of thumb, it’s only a good idea to think about paying off a personal loan early if you’re sure that you can do it in addition to covering all of your other monthly expenses. Plus, if you don’t have one already it’s also smart to take some time to build up an emergency fund first. Consider whether an emergency fund versus paying off debt makes most sense to you.