Making extra payments toward a personal loan, whether monthly or whenever you can, helps you save money in interest and pay off the loan faster.
When you make extra payments, you reduce the loan's principal—or the outstanding balance. Paying extra can also lower your future monthly payment amount if you have a variable payment schedule like a line of credit. However, be aware of lenders charging prepayment penalties for repaying a loan earlier. Discover how extra payments can affect your future loan payments and financial outlook.
Key Takeaways
- Extra payments affect future loan payments by lowering the total amount you owe.
- Applying extra money toward your loan can also reduce the amount of time you're in debt.
- Some loans have an early payoff penalty that could reduce the amount you'd save by paying off your debt early.
- You can use a personal loan calculator to determine potential savings.
Advantages of Making Extra Payments on Your Loan
One of the biggest advantages of making extra payments on your personal loan is that you can save money.
You Pay Less Interest
When your extra payments reduce your principal, you also reduce the amount of total interest you're charged (based on the principal).
Get Out of Debt Faster
In addition, extra payments shorten the length of time you're in debt. If you want to get out of debt faster, extra payments can reduce the time it takes to pay down the debt. When you have your loan paid off, you can put the money you were using to make extra payments toward paying down other debt or other financial goals like saving for retirement.
You can use a personal loan calculator to determine potential savings and to compare different extra payment amounts.
Note
If you have a student loan, you have the right to make extra payments on it without being charged a fee or prepayment penalty.
Disadvantages of Making Extra Payments on Your Loan
When considering whether to put extra money toward paying down your personal loan early, consider the possible downsides.
Prepayment Penalty
Check whether your lender charges a prepayment penalty if you pay off the loan sooner than the original loan term. Some lenders charge a fee when you don't keep the loan until the end of the term. Then, use a loan calculator to check whether the amount you would save in interest by making extra payments would offset the prepayment penalty. You might find that it's worth paying the penalty to be out of debt sooner, especially if you would still have interest savings left afterward.
Reduces Length of Credit History
Another consideration is how long a personal loan stays on your credit if you make extra payments. Monthly payments are reported to credit bureaus, which can help your credit score. Additionally, keeping the loan can contribute to a longer credit history. In fact, in some cases, your credit score might drop after you pay off a loan. However, generally paying down your debt is more beneficial to your credit history than paying a loan reliably for a few months longer.
Less Money Going to Savings
Finally, think about how the extra payments might impact your personal finances. If putting extra money toward a loan means you cannot pay other bills, this strategy can do more harm than good. Or, you could put the extra money toward an investment that could earn you more than you would save in interest by making additional payments.
You could also use extra money to build an emergency fund, which can ensure you can afford an unexpected major expense, such as a hospital bill or car repair bill.
Pros and Cons of Paying Off a Personal Loan Early
Pros
Pay less interest
Get out of debt faster
More money for long-term goals like retirement
Cons
Prepayment penalty
Reduces length of credit history
Less money towards savings like an emergency fund
Carefully consider your financial situation, and be sure you can handle the extra payments without straining your budget.
Tips to Help You Pay Off Personal Loans Early
If you want to pay off your personal loan early, you can take specific steps to make the debt repayment more manageable. These include:
- Make biweekly payments: Instead of monthly payments, consider making payments every other week, which will result in what amounts to an "extra" payment each month, accelerating your debt payoff. You can also add an additional payment to your biweekly payments. For example, if your monthly payment is $300, and you could put an extra $100 each month toward your debt paydown, consider making biweekly payments of $200.
- Cut back on unnecessary spending: You may find extra money to pay down your loans by reducing your spending. Review your budget and find places where you can cut costs, such as by eating out less or spending less on entertainment.
- Increase your income: Look for ways to make extra money, such as picking up extra shifts at work, getting a part-time job, starting a side hustle, or selling unused items. Put any extra money toward reducing your debt's principal.
- Refinance your personal loans: Another solution is to refinance your loans. If you can get a new loan with a lower interest (and a potentially shorter term), you can save on interest and pay off your debt sooner. Just make sure you have a plan to pay off your debt before you refinance.
Extra Payment Calculator
Using a personal loan calculator can help you get a sense of how much you could save over the life of the loan—and how quickly you can pay it off—by making extra payments.
For example, let's say you have a $10,000 loan with a term of seven years at a 15% interest rate. Your monthly payment would be $192.97. The total interest you'd pay on that loan would be $6,209.27.
If you want to pay off the loan faster, you could put an extra $100 toward the loan each month. With this plan, you could be out of debt in a little less than four years and save more than $3,000 in interest. With these extra payments, you'd be saving money in interest and be out of debt faster.
How Does Making Extra Payments Affect a Loan?
When you make an extra payment on a loan, it's usually applied to the principal balance, repaying the original amount you borrowed. Paying down the principal reduces the amount of interest you pay since your monthly payment consists of a portion towards the principal and interest on the outstanding balance.
Can I Make Extra Repayments on a Personal Loan?
Yes, you can make extra payments on a personal loan. Contact your lender to determine how extra payments are handled to ensure the funds get applied towards the principal. Be sure to ask if your lender charges a prepayment penalty for paying off your loan early.
Is It Worth Overpaying a Personal Loan?
Whether paying extra towards a personal loan makes sense depends on your financial situation and the amount of interest saved. Making extra payments on a personal loan gets you out of debt faster, reduces the amount of interest you pay, and can improve your finances.
However, it's important to balance paying off your personal loan faster with your other financial goals, such as building an emergency fund or saving for retirement. You'll also want to ensure prepayment penalties do not offset the interest savings.
The Bottom Line
A personal loan results in interest payments and can cost you more money over time. Paying down your debt faster can save you hundreds of dollars in interest while reducing your time in debt. However, before you devote a large portion of your budget toward making extra payments, make sure you have sufficient financial resources and a plan for reaching your other financial goals.
