Pros and Cons of Paying off Your Personal Loans Early

There are many consequences to borrowing money, with interest being one of the biggest. But while it’s obvious that personal loans come with interest attached, many borrowers are unaware of other fees that lenders sometimes tack on to a personal loan. They may charge a fee, on top of interest, simply for borrowing money from them in the first place. Some Lenders will even charge a fee if a borrower pays off a loan early.

personal loans

If you have personal loans, whether they’re payday loans, cash advances, or credit cards, there are several pros and cons you need to be aware of before discharging that debt.

What Are the Pros of Paying off a Personal Loan Early?

For most people, paying off a personal loan debt early can give them the freedom they need to pursue other financial goals. They may be able to save for a down payment on a house, move, or get more aggressive on their retirement savings. If they are paying off a car loan early, they may be able to reduce their insurance rates.

What Are the Cons to Paying off Your Loans Early?

For some, having a debt hanging over their head can be stressful. They may feel that paying off the debt early can give them some peace of mind. But there is one major downside to paying off a personal loan early.

The biggest con to paying off a personal loan early are prepayment penalties. Not all loans have prepayment penalties, however. Student loans and federal credit unions are legally barred from issuing prepayment penalties. However, state-chartered credit unions can charge them on certain personal loans. Other loans that may have prepayment penalties attached include:

  • Auto loans
  • Some personal loans
  • HELOCs
  • Mortgages
  • Payday loans

Why Do Some Lenders Charge Prepayment Penalties?

Lenders will charge a prepayment penalty as a way to recoup some of the interest they would lose on early loan repayment.

If you want to pay off your loan early, it’s crucial that you go over the term agreements first to look for any prepayment penalties. In most cases, a prepayment penalty is based on the percentage of the remaining loan balance interest. If you’re paying off the loan several years before the terms are up, you could be in for a large prepayment fee.

There is another con to paying off a loan early. Closing off an account on your credit report because of early repayment can cause a temporary dip in your score.

How Can You Avoid Paying Prepayment Penalties?

You can try to refinance your loan to find a better term or interest rate. Depending on your financial goals, it may also be worth it to pay the loan off early and take the prepayment penalty hit. If paying early will save you on interest despite the penalty, it can be a good idea to pay off the loan early. But if your prepayment penalty would be the same or more than the interest you’d owe on loan, you may want to continue paying the loan as usual. The final decision depends on the math involved, and your tolerance for having a loan out.

How Can You Avoid Paying Prepayment Penalties?

Prepayment penalties can vary by lender, and some may not even have prepayment penalty fees in their contracts. Wells Fargo and Discover, for example, do not charge prepayment fees on their loans.

Before you sign for a loan, always go over the term agreements first. Be careful to shop around for a loan from different lenders so you can make the best, most informed decision for your current and future finances.

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