Pros and Cons of Paying Off a Personal Loan Early

14 May 19

Pros and Cons of Paying Off a Personal Loan

In some instances, it may in fact make more sense to put your money to better use. Here are a few pros and cons of paying off your personal loans early.

Pro: Save Money

Paying off your personal loan debt early can save you a substantial amount of money. For instance, if you have student loan debt of $20,000 with a 7% interest rate, and a loan term of ten years then paying off the balance in full will save you almost $8,000 in interest. You may want to think of paying off your debt as a sort of investment. By paying off $20,000 in loan debt today, you are getting a rate of return of 7%, which isn’t too shabby.

Pro: Free Up Your Cash Flow

Paying off your personal loan in full will free up your cash flow. If you only make the minimum payments on your loan then you will be required to make payments for a substantial amount of time. However, if you pay off your loans in full then you can free up the money used to make payments. This money can be used to pay off other debts or to invest for your retirement.

Pro: Lower Your Debt-to-Income

By paying off your personal loans in full you can lower your debt-to-income ratio. This is the percentage of your income that goes straight to paying off your debts. This will make it much more likely that a lender will approve you for more credit or for a mortgage. Lenders usually want debt-to-income rations that are lower than 36%.

Con: Makes More Sense to Pay Off Other Higher Debts

If you have other debts that have higher interest rates, like credit card debt, then it is recommended that you pay off that debt first. For instance, if you have $20,000 in credit card debt with a 14.9% interest rate and the same amount of debt at 7% then paying off your credit card debt will save you much more money. Additionally, personal loans have less of an influence on your credit score than credit cards. Because of this, paying off your credit cards first will have a bigger impact on your credit score. However, this doesn’t mean that you should miss any of your credit card payments.

Con: Draining Your Savings

It is not recommended that you pay off a personal loan early if it means taking away money from your savings account or emergency fund. It is more important to have cash set aside in case of an emergency then saving money by paying off your debt early. You should also take into consideration the importance of saving for retirement.

Con: It May Make More Sense to Invest Instead

If the interest rate on your personal loans is reasonable then it may be a better idea to invest the money that you would have used to pay it off early instead. However, keep in mind that investing does come with some risks and you have to take into consideration the fees, commissions and taxes that you’ll have to deal with on any investment gain.

If you decide that paying off your loans in full is not something that makes sense for your financial situation then you may want to consider consolidating that debt into a single loan instead. This makes financial sense if the loan you get by consolidating has a lower interest rate than the one you are receiving now.