Many people find that they have to take out a loan of some type at least once in their lifetime. In some circumstances, you may have the opportunity to repay a personal loan off ahead of schedule. In that scenario, you may wonder whether that is the best plan of action.
The obvious option is to repay the loan right away, foregoing additional interest payments that can rack up over time. Carrying debt can be stressful, so it’s natural to consider this tactic. That said, there are some important questions to consider before taking action.
If you have a personal loan, you might consider answering the questions we’ve listed below to see if there are better, more financially beneficial options to repaying your personal loan early.
What Is My Personal Loan Interest Rate?
If you have a low interest rate on your personal loan, you might consider alternative ways to use your money than to pay the loan off early.
For example, if your loan has an interest rate of 5% (generally considered a reasonable interest rate), the money you would use to pay off the loan might be better spent in the stock market, where the average annual return is 9.2%.
On the other hand, if your interest rate is high, you should consider paying the loan back as soon as you can to save yourself money in the long run.
What Other Debts Am I Carrying?
Before paying off your personal loan early, consider any other more expensive debts you may have. This could include:
- Credit cards
- Car title loans
- Payday loans
These types of debt tend to have a higher interest rate than a personal loan. If you are carrying high-interest debt, it’s best to focus on paying that debt down before repaying your personal loan early. This can save you a significant amount of money in the long term.
If, however, you are only carrying debt (of another type) with lower interest, you might consider paying off your personal loan early. One example is if your only other debt is a mortgage. Mortgages tend to have lower interest rates than personal loans and also come with favorable tax breaks, so it would make the most sense to pay off the personal loan early in this situation.
Are There Penalties For Early Repayment?
Before taking steps to pay back your personal loan early, be sure to verify with the lender that there are no penalties for early repayment. Some personal loans will charge a fee known as a prepayment penalty if you pay the loan off before the final payment due date.
Even if there is a prepayment penalty, it could still be financially shrewd to pay off your personal loan early. Compare the prepayment penalty to the interest you would pay if you stuck to the original payments schedule. If the amount you would pay in interest is greater than the penalty, you should repay the loan early.
Is My Money Better Spent Elsewhere?
If you pay off your personal loan early, you could be losing out on other financial opportunities. For example, if you’re putting extra cash towards your loan repayment rather than contributing to your 401(k) at work, you might be forfeiting any employer match you could have received in addition to earnings from your investment. Those types of missed opportunities can add up quickly.
You might also consider whether or not you have a healthy emergency fund. If not, setting extra money aside for emergencies could prove to be a wiser investment than paying off a personal loan early. The answers to each of the questions outlined above will be special to you and your circumstances. The point is to conduct a comprehensive evaluation of your financial situation before making any big decisions.