You can pay off a personal loan early by making biweekly & extra payments, rounding up monthly payments, increasing income, and strictly following a personal budget.
An early loan settlement can offer you a few financial and psychological benefits such as interest savings, improved credit score, and better financial stability with reduced financial strain.
An early loan settlement will also strengthen your financial profile for future lenders that can offer few flexibilities in the future. However, some lenders may ask for additional payment for an early loan settlement that varies.
Statistically, early paying off a $10,000 loan at an interest rate of 9.41% for five years will offer you a net savings of approximately $1,278 in interest by paying it off one year early.
Similarly, paying off debt can improve your debt-to-income ratio and potentially boost your credit score by 30 to 50 points, per Experian.
Another study from Experian showed that 39% of adults struggle to handle 400 unwanted sudden expenditures. So, any early loan settlement directly helps handle such unwanted cash requirements.
6 ways to pay your loan early
Here are the ways to make your loan payment faster.
Make biweekly payments
Instead of making monthly payments, you can pay your loan twice a month. It will help repay the principal amount quicker than expected. Consequently, summing up additional money would save interest costs over time.
Let’s consider an example where you have a $20,000 personal loan with an interest rate of 9.41% and a term of 5 years (60 months).
Using our loan calculator, the monthly payment would be approximately $419.84.
To implement a biweekly payment plan, you would divide your monthly payment in half and make a payment every two weeks, which will be $419.84 / 2 = $209.92.
The number of Biweekly Payments in a Year is 26 and the annual payments would be (26 biweekly payments × $209.92) or, $5,457.92
Per the biweekly payment plan, you make the equivalent of one extra monthly payment per year. Since, there are 52 weeks in a year, which results in 26 biweekly payments (as opposed to 12 monthly payments).
For the $20,000 loan @9.41% for 5 years, your total payment would be $24,649 which contains interest payments of $4,649.
By switching to a biweekly payment plan:
- You shorten the loan term by approximately 6 months.
- You save approximately $541 in interest over the life of the loan. ($5,190.32 – $4,649)
Round up monthly or, biweekly payments
While paying for the monthly loan payments, round up the amount to the nearest $50 or $100. For example, if your monthly payment is $365, make it $400. Putting in extra effort to pay an additional $35 would eventually shorten your debt.
Let’s assess the impact of rounded-up monthly payments.
Let’s assume that you have a loan of $10,000 at 9.41% interest for 5 years. Your monthly payment would become $210.99.
Instead of paying $210.99 each month, you decide to round up to the nearest $50, making your monthly payment $250. This extra $39.01 will go directly towards the principal.
Per the original loan amortization plan, you will pay $12,659.45 over 5 years. And, rounding up the amount to $250 would cost you $11,935 in 4 years.
In summary, making an extra $39.01 per month saves 1 year of your time and $724.45 interest ($2,659.45 (original) – $1,935 (new)).
Loan Payment Savings Calculator
Make extra payments when you can
Making extra payments than the required monthly amount can help you repay your loan faster. This is similar to rounding up but, you can add whatever the extra amount you can.
The theory is the same. You need to add extra money on top of your regular loan payment and the extra payment would eventually save future interest.
Here are some tips to make extra loan payments:
- Cut unnecessary expenses and be strict with your financial goals.
- Sell items you no longer need and use the proceeds to pay down your loan.
- Round up payments and contribute something extra.
- Find additional part-time work solely to make additional loan payments.
- Set up automatic payments for an extra amount each month to ensure consistency.
Use windfall toward the loan
A windfall is an unexpected or unplanned financial gain such as a tax refund, work bonus, lottery winning, gifts, or inheritance.
If you have any such unwanted gains, utilize the amount to repay your loan. It will be treated as an additional contribution that can eventually save your interest and make the loan terms shorter.
Before using a windfall, ensure you have an emergency fund and other financial priorities covered.
Direct the windfall towards your loan’s principal balance. This reduces the principal amount and, subsequently, the interest.
You also need to confirm that there is no penalty for making early payments of your debt principal.
Refinance your loan for a shorter term
Refinancing refers to replacing one loan with another. Let’s assume that you have a loan with a $4500 balance. And, you have 3.5 years to repay the loan.
If you are confident about your regularity of income, you can refinance your existing debt for a shorter term and quickly repay the debt balance than expected.
In 2021, data from Freddie Mac indicated that around 30% of homeowners who refinanced their mortgages opted for a shorter loan term. This is clear that the users of personal loans applied this strategy to efficiently manage their debts.
In 2024, the refinance rate decreased due to the overall economic crisis. However, if you are confident about your income, you can always opt for a refinance scheme with a shorter term.
Use the snowball or avalanche method to make debt reduction
Debt snowball and avalanche methods are the two methods, both focusing on repaying loans from different angles. The snowball method focuses on repaying the smaller debt first whereas the avalanche strategy guides to repay the most costly loans faster with additional savings.
In both cases, you need to prioritize your debts and make arrangements from extra savings or funds to pay off your loans.
Is it good to pay off loans early?
Early debt settlements can be benificial from financial and psychological aspects.
With an early payoff, a person can save interest, and free up himself from debt which effectively contributes to his credit score.
Additionally, early loan settlements reduce debt to income ratio which can help you get eligible for another loan in the future.
Paying off the loans also helps reduce financial stress and provides financial freedom. A survey by the American Psychological Association found that 72% of Americans feel stressed about money at least some of the time, and reducing debt is one of the top strategies people use to alleviate this stress.
Potential drawbacks of paying loans early
Some loans have prepayment penalties that can negate the financial benefits of paying off the loan early. The Consumer Financial Protection Bureau (CFPB) notes that about 2% of mortgage loans have prepayment penalties, which can cost borrowers thousands of dollars.
Money used to pay off a loan early could be invested elsewhere for potentially higher returns. So, there is an opportunity cost calculation that needs to be considered.
Conclusion
This is always better if you can settle loans early. Such a financial strategy can offer you increased financial freedom and stability. You should only pay off your debts before maturity if your income supports regularity.
