If you have a personal loan, you may wonder whether you can pay it off early, and if doing so means you will pay less interest. The answer to both of those questions is yes. However, that doesn’t necessarily mean paying off your loan ahead of schedule is a good idea.
Personal loans sometimes come with prepayment penalties, which could eat away at any savings in interest. Here’s everything you need to know about early payoff of a personal loan.
Understanding Personal Loans
If you need funding, personal loans can provide you with a lump sum of money to be repaid over a set term as closed-end credit. Personal loans may have repayment terms ranging from 12 months to seven years, and some lenders may offer longer loan terms.
Can you pay off a personal loan early? Yes, you can pay off personal loan debt early. Paying off your personal loan early may minimize your interest costs, but some personal loans may include a prepayment penalty personal loan clause.
Definition and Purpose of Personal Loans
By definition, personal loans provide borrowers with funding that can be used for personal, family, or household purposes. The borrower receives a lump sum of money and agrees to repay the debt over a set term. The terms and conditions of a personal loan may include interest charges and origination fees.
The difference between personal loans and other loans is that personal loans have few restrictions on their use. Student loans, for example, must be used for education purposes. Other examples of closed-end credit — including mortgage loans and auto loans — have clear limitations on their use.
Personal loans give the borrower a lump sum of money — not revolving credit — that can be used for a variety of purposes.Lenders may offer online personal loans up to $100K, and borrowers may use the funds to finance large purchases or consolidate debt.
Loan Terms and Conditions
A personal loan agreement may include certain terms and conditions, such as the annual percentage rate (APR), term length, and the potential consequences of a default. The consequences of defaulting on a loan can be severe. Lenders may sue you for breach of contract, and your credit score may plunge if you fail to make required payments on a personal loan.
The terms and conditions of a personal loan agreement may also include a prepayment penalty personal loan clause. You may minimize your interest costs and improve your debt-to-income ratio when you pay off personal loan debt early, but prepayment penalties can add up if your loan charges prepayment fees.
Prepayment penalties generally have to be disclosed in your loan agreement. It can be helpful to review the terms and conditions of a personal loan offer before accepting and signing the agreement.
Can You Pay Off a Personal Loan Early?
Borrowers may pay off a personal loan at any time. (Borrowers facing financial hardship may request deferred payment loan relief.) However, depending on your lender, early payoff may come with a cost. While some lenders won’t charge any fees for paying off your loan ahead of schedule, others may charge a prepayment penalty.
Lenders may calculate the prepayment penalty as a percentage of your outstanding loan balance. It might start out around 2% and then decline each year of the loan until it reaches zero. This set-up allows the lender to recoup any interest lost as a result of early repayment of the loan balance. The calculation method will vary from lender to lender, but any prepayment penalties would be outlined in your loan agreement.
Exploring Early Loan Repayment Options
Borrowers may pay off a personal loan before the designated repayment period ends. For example, a borrower with a 60-month repayment term may consider paying off the loan in less than 60 months. Paying off a personal loan early may minimize your interest costs.
Prepayment Penalties
Some lenders may charge prepayment penalties if you pay off a loan early. As mentioned earlier, prepayment penalties generally have to be disclosed in your loan agreement. It can be helpful to review the terms and conditions of a personal loan offer before accepting and signing the agreement.
Definition and Purpose of Prepayment Penalties
A prepayment penalty is a fee that lenders may charge if you pay off a loan early. Personal loan lenders typically charge interest, but borrowers may minimize those interest charges by paying off the loan early. That’s why some lenders may charge prepayment penalties to recoup any interest lost as a result of early repayment of the loan balance.
Borrowers may have less of an incentive to prepay their loan if there’s a prepayment penalty risk. If your lender charges a prepayment fee, you’ll want to do the math and compare what you’ll save in interest vs. what you’ll pay in prepayment fees.
Checking for Prepayment Penalties
Lenders generally have to disclose financing terms and conditions when offering consumer loans, including the existence of any prepayment penalties. Prepayment penalties would be outlined in your loan agreement, and you may decline a loan offer if you’re unhappy with the proposed terms and conditions.
You may contact your lender for clarification if you’re unsure about any terms of the loan agreement. The Truth in Lending Act generally prohibits lenders from engaging in unfair or deceptive consumer lending practices.
How to Pay Off a Personal Loan Early
Below we highlight how you may pay off a personal loan early:
Assessing Your Financial Situation
You may evaluate your financial standing and consider whether early loan repayment is feasible and right for you. Budgeting and financial planning may guide you in the decision-making process if you’re interested in minimizing your interest costs.
Strategies for Early Loan Repayment
Here are some ways of paying your loan off early:
1. Increasing Monthly Payments
Increasing monthly payments can accelerate loan repayment and reduce interest costs. For example, you may consider making extra payments toward loan principal each month. This can promote early loan repayment and minimize your total interest charges.
2. Making Lump Sum Payments
Making occasional lump sum payments toward loan principal in addition to your regular monthly payments can promote early loan repayment. Any extra funds you receive — such as bonus compensation, merit pay, or a tax refund — can go toward paying down your loan balance.
3. Refinancing the Loan
Refinancing your loan for a lower interest rate and shorter repayment term can give you a path toward early loan repayment. In terms of ways to refinance a personal loan, you can borrow a new loan to pay off an existing loan in your name. Getting a lower interest rate and shorter repayment term can reduce your interest costs and allow you to pay off the debt sooner.
The Takeaway
Paying off a personal loan early can minimize your interest costs and improve your debt-to-income ratio. Some lenders may charge a prepayment penalty to recoup any interest lost as a result of early repayment of the loan balance. Other lenders may advertise their personal loan products as having no prepayment penalties.
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
Please understand that this information provided is general in nature and shouldn’t be construed as a recommendation or solicitation of any products offered by SoFi’s affiliates and subsidiaries. In addition, this information is by no means meant to provide investment or financial advice, nor is it intended to serve as the basis for any investment decision or recommendation to buy or sell any asset. Keep in mind that investing involves risk, and past performance of an asset never guarantees future results or returns. It’s important for investors to consider their specific financial needs, goals, and risk profile before making an investment decision.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. These links are provided for informational purposes and should not be viewed as an endorsement. No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this content.
Communication of SoFi Wealth LLC an SEC Registered Investment Advisor
SoFi isn’t recommending and is not affiliated with the brands or companies displayed. Brands displayed neither endorse or sponsor this article. Third party trademarks and service marks referenced are property of their respective owners.
Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at here. Liz Young is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Her ADV 2B is available at here.
7 budgeting secrets to help you pay off debt
There’s no shortage of debt in America. Total household debt reached $11.67 trillion in September 2022. But no matter how large or small your balance may be, budgeting to pay off debt of any kind can set you up for a stronger financial future.
In this article you’ll learn how to budget to pay off debt as well as soak up some smart tips for lowering your balances. Whether you have maxed-out credit cards, a high-interest auto loan, student loans, or any other type of outstanding debt, you’ll be ready to tackle them all.
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Lowering your debt is an admirable goal. But in order to achieve it, you need a plan. And the best type of planning to pay off debt is creating a budget and sticking to it.
What exactly is a budget? It’s a way to track your income and expenses, so you know exactly what you’re spending and where.
By understanding these numbers, you can make decisions about what areas to scale back in spending in order to put your money toward other things—like paying off your debt.
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How to pay off debt? Here are seven strategies that will make a big difference.
In order to budget to pay off debt, you need a clear understanding of how much money you actually have to work with. If you have a job, take a look at your paystub (and your partner’s, if you share finances) to see your take-home pay.
Take-home pay isn’t your salary divided by 12 months. It’s actually less than that; it’s the amount of money going into your bank account after deductions like taxes, health insurance premiums, and 401(k) contributions.
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Next, calculate all of your current fixed expenses each month — these are the costs that don’t vary:
- Rent or mortgage
- Car payment
- Cell phone bill
- Streaming services
- Child care
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Your next task is to pull out your recent bank and credit card statements to find out how much you’re spending on non-fixed expenses. These things still might be necessary (like gas and groceries), but you have control over how much you actually spend.
It might be uncomfortable to categorize every single transaction from the last month, but it’s an important step in creating a budget for paying off debt. Some ideas for categories: food, shopping, health/wellness, travel, and gas.
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With all of your spending habits identified, it’s time to identify where you can scale back. Perhaps you can cancel some streaming subscriptions or pick a cheaper cell phone plan. There’s almost always room to remove something from your budget, which gives you more cash to put toward extra debt payments.
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You can scale back on both essentials and non-essentials, or a combination of both. Set monthly spending limits in each area so you can still enjoy the things you love, but with an awareness of the cost. For instance, give yourself a weekly grocery budget instead of browsing through the aisles without a set plan.
Another strategy is to create a spending alert on your banking app that notifies you when you’re close to a certain dollar amount at a certain retailer or category, like Amazon or restaurants.
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Once you have a sense of your current spending and areas where you can scale back, it’s time to create a debt pay-off plan. Choose how much extra money you want to put toward your debt balances each month. You can start off small as you create new spending habits, or make an aggressive plan if you’re ready for change. The idea is to find a balance that lasts over time, rather than fizzling out after a few short weeks.
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If you know how much extra you can reasonably pay on your debt, automate those extra payments to correspond with your paycheck. That way you’ve already made the additional payment before you start spending in other areas, like eating out or shopping.
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Using a budget is an essential part of reaching any financing goal, whether it’s paying off debt early or saving up for a large purchase. It also helps you prepare for the future by creating savings opportunities for emergencies and retirement. That can lead to great confidence that you can weather life’s ups and downs.
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If you have outstanding debt as well as some money in a savings account, you may wonder if you should simply use that cash to put a dent in your balances. In reality, it’s smart to have certain savings goals funded before using any leftover funds for your debt.
For instance, most financial experts recommend having anywhere from three to nine months’ worth of expenses tucked away in case you lose your job. Additionally, you should do your best to regularly contribute to your retirement fund so that you can ideally benefit from long-term growth.
Here are five other ways to pay off debt.
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Consolidating your debt refers to taking multiple outstanding balances (usually credit cards) and paying them off with a single debt consolidation loan. Then you just have one monthly payment to worry about. And in an ideal scenario, you could qualify for a lower interest rate that saves you money.
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Another option for credit card debt is to do a balance transfer. That entails opening a new credit card and rolling other balances onto that new account. Oftentimes, there is a fee associated with this strategy, usually charged as a percentage of your debt and added to your balance.
On the plus side, some balance transfer credit cards offer a low or even 0% introductory APR, so you essentially put a pause on making interest payments as long as you make at least the minimum payment on time each month.
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You can also apply to refinance a loan in order to secure a lower interest rate. You can also adjust the term to stretch out monthly payments over a longer period of time; while that might lower how much you pay each month, just remember that it usually means you pay more in interest over time. Student loans, mortgages, auto loans, and personal loans can all be refinanced to adjust your loan terms. Just watch for costs like origination fees that can diminish the benefits of refinancing.
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There are two successful ways to stay motivated while paying down debt. The first is to identify your smallest balance and throw all your extra payments at that one (while still making minimum payments on your other balances). Experiencing that first success could deliver the inspiration you need to keep going.
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Another common debt payoff strategy is to pay off the highest interest rate first. After all, that’s the bill that’s accumulating the most interest. Choosing this bill as your target for extra payments can save you the most money over time.
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- Checking accounts are ideal for everyday transactions but earn little or no interest. Savings accounts are better for storing and growing your money — they earn higher interest but often restrict how many withdrawals you can make per month.
- An emergency fund is a key financial safety net. Aim to have three- to six-months worth of living expenses tucked away in a separate account that earns interest, but allows you to access the money if needed (such as a high-yield savings account). In some situations, it may be appropriate to have up to 12 months of living expenses saved.
- To get into the savings habit, consider having 10% of your paycheck directly deposited into your savings account. Or, set up a small automatic recurring transfer from your checking account into your savings account on the same day each month.
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Creating a budget for paying off debt is a move impossible to regret. You’ll feel more in control of your finances, and once those balances are gone, you’ll have cash flow ready to boost your other savings goals.
Learn More:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
Please understand that this information provided is general in nature and shouldn’t be construed as a recommendation or solicitation of any products offered by SoFi’s affiliates and subsidiaries. In addition, this information is by no means meant to provide investment or financial advice, nor is it intended to serve as the basis for any investment decision or recommendation to buy or sell any asset. Keep in mind that investing involves risk, and past performance of an asset never guarantees future results or returns. It’s important for investors to consider their specific financial needs, goals, and risk profile before making an investment decision.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. These links are provided for informational purposes and should not be viewed as an endorsement. No brands or products mentioned are affiliated with SoFi, nor do they endorse or sponsor this content.
Communication of SoFi Wealth LLC an SEC Registered Investment Advisor
SoFi isn’t recommending and is not affiliated with the brands or companies displayed. Brands displayed neither endorse or sponsor this article. Third party trademarks and service marks referenced are property of their respective owners.
Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Liz Young is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Her ADV 2B is available at www.sofi.com/legal/adv.
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Featured Image Credit: designer491/istockphoto.
