Paying off a personal loan early can save you a ton in interest and make it easier to qualify for a home loan or auto loan. However, whether it’s the best use of any extra funds depends on your financial situation. We cover scenarios where it might make sense and strategies you can use to pay off a personal loan faster.
Does It Make Sense to Pay Off Your Personal Loan Early?
Whether it’s a good idea to pay off a personal loan early depends on your financial circumstances. If you have multiple debts and your personal loan has the highest interest rate, paying it off first could save you the most interest.
However, if your personal loan has a lower rate than your other debts, like credit cards, it’s usually better to focus on paying off those first to save more on interest, says Michael Collins, chartered financial analyst and founder of WinCap Financial.
Note that most personal loan companies don’t charge prepayment penalties, but some do. If your lender charges one, weigh the benefit of saving interest against the cost of the fee.
Benefits of Paying Off a Personal Loan Early
The main benefit of paying off your personal loan more quickly is that you could save thousands in interest. Some additional advantages include:
— Become debt-free more quickly. If you want to be debt-free, paying off your loan ahead of schedule can help.
— Improve financial flexibility. Paying off a personal loan can free up cash to tackle other financial goals, such as saving for retirement or funding your child’s college education.
— Lower debt-to-income ratio. Eliminating personal loan debt can lower your DTI and improve your chances of qualifying for a mortgage or car loan.
Downsides of Long-Term Debt
Having long-term personal loan debt comes with many disadvantages. Generally, the longer your loan term, the higher your total borrowing costs. Plus, borrowers who take on long-term debt may face the risk of overextending themselves financially, says Taylor Kovar, certified financial planner and founder at 11 Financial.
Strategies to Pay Off Your Personal Loan Faster
Here are some steps you can take to pay off a personal loan sooner.
— Make extra lump sum payments. Whenever you have extra funds available, use them to make a lump-sum payment on your personal loan. To maximize the payment, ask the lender to apply the payment to your principal balance or original loan amount. “When you make a principal-only payment, it can substantially reduce your overall interest and repayment time frame,” says Kovar.
— Make biweekly payments. Paying your loan in biweekly instead of monthly installments can also help. “There are 52 weeks in a year, so paying bi-weekly means making an extra month’s worth of payments in a year,” says Matt Bacon, a certified financial planner at Carmichael Hill. When switching to biweekly payments, split your monthly payment in half.
— Trim expenses. If you need to free up money for additional payments, review your budget to see where you can cut expenses. For example, look at your subscription services and cancel the ones you aren’t using. You could also reduce spending in other areas, such as eating out or traveling. After you’ve reduced or eliminated an expense, use those funds to pay off your personal loan early.
— Consider refinancing. Another way to get out of debt faster is to refinance your personal loan, which involves paying off your current loan with a new one. If you can qualify for a lower rate, it can lower your monthly payment, making it easier to make extra payments. However, there are some potential downsides to keep in mind. For instance, if you can’t qualify for a lower interest rate, it’s best to just make extra payments on your current loan.
Tips for Staying Motivated While Paying Down Debt
To stay motivated, Kovar recommends that you set specific goals, track your progress and celebrate milestones along the way. For example, if you have a 60-month personal loan, set a goal to pay it off in 48 months. If you want to minimize the need to apply for a large personal loan in the future, Kovar suggests saving regularly, budgeting and avoiding impulse spending.
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How to Pay Off a Personal Loan Faster originally appeared on usnews.com
