When it comes to paying back any type of term loan, borrowers always want to know if they can pay back their loan early.
And for good reason. Borrowing can be expensive. If your finances change, why wouldn’t you want to pay off your loan? Less debt is great and nothing having to keep track of payments can relieve pressure and stress. Keep reading for everything you need to know about paying off your term loan.
Can You Pay Off Your Personal Term Loan At Any Time?
If your finances improve over time or you come across a lump sum of money, you may be able to pay off your personal loan early. However, you’ll need to check the fine print on your loan contract to see if a penalty fee will apply for paying your loan off before the term ends.
While some lenders allow you to repay your loan early without penalty, other lenders may charge an early prepayment penalty fee to make up for any lost profit they would have otherwise earned on the interest portion of your loan. Not only should you find out if such a fee will be charged, but you’ll also want to find out how much that fee will be.
In some cases, the prepayment penalty fee may be a percentage of your outstanding loan balance. Other times, it may be a flat fee. Before you decide to pay off your loan early, check your loan contract or speak with your lender to find out the financial implications.
What Is A Personal Term Loan?
A personal loan term refers to the time you have to pay back your loan. Generally, these terms vary between 6 months to 5 years. When you negotiate a term loan, you borrow a specific amount of money and pay it back over a set amount of time by making regular payments.
Should You Pay Back Your Personal Term Loan Early?
Whether or not you choose to repay your personal term loan early depends on a few factors.
Your Financial Situation
Getting rid of extra debt is always a goal you should have, and if your finances are stronger today than they were when you initially took out your loan, perhaps paying your loan off early may be a wise choice. Just keep in mind that any extra funds you may have available to you could also be used elsewhere. Be sure to apply your extra funds appropriately.
Emergency Funds
It’s always a good idea to have a financial cushion to fall back on for a rainy day. Anything can happen in the future that you may not expect, which could require a large sum of money to deal with. Make sure you have a sizable emergency fund in place before putting extra cash towards your personal loan.
Other High-Interest Debts
You may have other loans or credit accounts that you’re still paying off. If so, consider the interest rates that you’re paying on those other debts before paying your personal term loan off early.
For instance, credit card debt can be difficult to pay down if you carry a high balance month after month with a 20%+ interest rate. In this case, it might make more sense to pay this debt off first before paying off other debt at a much lower rate. You’ll need to crunch the numbers to determine what makes more financial sense.
Investment Earning Potential
Investing your capital is a smart way to get your hard-earned money to work for you. There may be a variety of investment opportunities available to you that can help you earn a passive income in interest earnings.
If your personal loan comes with a higher interest rate compared to what you could potentially earn if you invested the money somewhere else, it might make more sense to pay off your personal loan early. But if your interest rate is lower than the potential interest you can earn in investment, you may be better off investing instead.
Pros And Cons Of Paying Your Personal Term Loan Early
There are plenty of perks and drawbacks of paying off your personal term loan early to consider before deciding what to do with your extra cash.
Pros Of Paying Your Personal Term Loan Early
- Save on interest. Your personal loan will cost you a lot less in interest by paying it off early. Depending on the rate you’re being charged, this could translate into thousands of dollars potentially saved.
- Reduce your monthly debt obligations. Paying off your personal loan will take one more bill payment off your plate. That monthly payment that would otherwise have gone towards paying off your personal loan would then be available for other purposes.
- Lower your debt-to-income ratio. Your debt-to-income ratio refers to how much of your income is dedicated to paying off your existing debt and is a key metric that lenders use to determine your creditworthiness. Paying off your personal loan early will reduce your overall debt, and therefore lower your debt-to-income ratio. In turn, you may have a higher chance to qualify for lower rates and better terms on future loan products.
Cons Of Paying Your Personal Term Loan Early
- Prepayment penalty fee. As mentioned, you may be subject to an early prepayment penalty fee for paying off your loan before the end of the term. Depending on how this fee is calculated, it could end up costing you quite a bit. Even though you’ll save on interest, a penalty fee could cancel out this benefit. Make sure to do the math before deciding to pay off your personal loan early.
- Less opportunity to build credit. Making timely bill payments is one of the biggest factors that can impact your credit score. The more timely payments you make towards paying down a loan, the better it can be for your credit score. By eliminating your personal loan early, you’re effectively removing one avenue of payment history.
Other Ways To Pay Back Your Personal Term Loan
If your lender does not allow you to pay off your personal loan early, you may have other alternatives available to pay off your personal loan faster:
Refinance Your Personal Loan
Refinancing involves paying off an existing loan with a new loan. Ideally, the new loan will come with a lower rate and better terms. If you can qualify for a lower interest rate with a refinance, this could save you money in interest. And if you opt for a shorter term, you could pay your loan off much faster.
Request A Payment Frequency Change
Making loan payments on a bi-weekly accelerated basis compared to a monthly basis allows you to make one extra monthly payment per year. This can help you save on interest costs, plus pay off your personal loan sooner. Ask your lender if it’s possible to change your payment schedule if your finances permit.
Alternatives To A Personal Term Loan
A personal term loan is a great option for any consumer looking to borrow money, but of course, it’s not the only option out there. Here are two of the other most common ways to borrow money when you find yourself in need of some extra cash.
A Line of Credit
A line of credit can be secured or unsecured and allows you to access funds with cheques, debit cards, bank machines (ATMs), and online banking. You will have a credit limit and be able to borrow as much or as little as you need, and you’re only required to pay interest. Principal payments are only required after the draw period ends which can be 10 to 15 years later. Payments will be different each month, depending on interest rates (variable rate) and the amount of credit you have used. If you don’t borrow, no payments are necessary.
Credit Cards
When you apply for a credit card, you are given access to funds up to a set limit. You can use these funds for a variety of purchases or cash advances, but you will want to repay them quickly. Credit cards usually have much higher interest rates than other borrowing options, however, low-interest credit cards also exist.
Credit cards are a great option for small expenses. Depending on the card you choose, it can offer valuable rewards like travel miles, cashback options, or points for groceries, fuel, or other purchases.
Bottom Line
When it comes to borrowing money, you have a variety of choices. Most big banks and other lenders have a set of similar options available, but they may have slightly different terms, interest rates, fees, and penalties. You’ll want to shop around to find the one that suits your needs the best.
