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Can You Pay off Loan Early To Avoid Interest?

Borrowing money is not free. There is always some price that you pay to borrow some cash from a lender, no matter what the loan is for. The only exception is when you are able to borrow money from a friend or family member at zero interest. But not everyone has that option. Lenders make money by charging borrowers interest on the loan balance.

Financial advisors often encourage borrowers to pay off their personal loans and auto loans early to save money on interest. In many circumstances, this is an excellent idea for minimizing the out-of-pocket costs associated with taking out a loan. However, it is not possible in all instances, so it is important to research the lender and the loan you are considering beforehand.

Can You Pay off a Personal Loan Early?

Depending on your lender, you may be able to pay off your personal loan early. The exception will come with lenders that charge prepayment penalties for their personal loans. 

If your lender doesn’t charge a prepayment penalty, then you can likely pay off your personal loan early. Every little bit of extra cash you pay on your loan over the monthly payment will save money on the total amount you will have to pay in interest.

Can You Pay off a Car Loan Early?

Similar to personal loans, you can pay off your auto loan early to save on interest and own your car outright faster. Some lenders may charge prepayment penalties on auto loans but, in some cases, the fee might be worth the amount you will save by paying off the car early.

Why Pay Off Your Loan Early?

There are several excellent reasons why it might be wise to pay off a personal or car loan early. Here are a few of the benefits you could receive after paying your loan ahead of when it’s due to be repaid:

Save On Interest

When you pay off a loan early, you can save a considerable amount of money on interest payments. Whether it is an auto loan or a personal loan, each month the interest rate is applied to your balance which causes it to grow. If you are able to pay off your loan early, that will mean there are several months worth of charges you will never have to pay because the balance the interest rate is applied to will be zero. 

Open Up Your Monthly Budget

Debt payments have a tendency to take over our budget. Your personal or auto loan could be eating up a considerable portion of your income every month, making it difficult to put your money towards what you actually want. Paying off your personal or car loan early could free up your budget to save up for that trip to Europe you want to take next summer or build up an emergency fund so you can avoid wracking up further debt in the future.

Improve Your Debt-to-Income Ratio

Your debt-to-income ratio compares how much money you bring in every month to your debt obligations. Your debt-to-income ratio can determine your overall financial health because having a ratio too high can mean you are living paycheck to paycheck with a problematic amount of debt. Additionally, potential lenders will look at your debt-to-income ratio when determining your approval. Minimizing your debt by paying off your personal or car loan early can improve your chances of accessing the financial opportunities you want.

Avoid Going Upside Down on Your Car Loan

There is a unique risk that comes with paying off a car because of how quickly they depreciate in value. It’s often said that the minute you purchase a car and drive off the lot, its value plummets. If you pay off a car too slowly, you risk owing more on your car than it is worth. When this happens, it is referred to as being upside down on your car loan. This can become a major issue if your car becomes totaled in an accident because the insurance pay out might be less than what you own on the car loan. Paying off your car loan early could significantly reduce that risk. 

Possible Drawbacks To Be Aware of When Paying Off Your Loan Early

While there are many potential benefits to paying off your loan early, there are also drawbacks that you should consider before making any decisions. As mentioned before, some lenders charge prepayment penalties on early repayment. Some of those prepayment penalties could be worth what you can save on interest, while in other cases, they will cost you more money than you can save. 

Another thing to keep in mind when deciding whether to pay off a loan early is whether you have other debts that have a higher interest rate. When paying off balances, it is smarter to pay off the debts that have the highest interest rates first before paying off your lower interest debt. So, before moving ahead with paying off your loan early, take a look at the interest rates on your credit card balances or other debts and make sure that there isn’t another balance that should be the higher priority.

Strategies for Paying off Your Loan Early

Even though paying off your car loan or personal loan early might be a really good idea for your finances, that does not mean it is necessarily an easy task to accomplish. If you have a limited budget, it might be particularly challenging to find room to pay off your loan sooner. There are some strategies and tips that might help you put more money towards the remaining loan balance each month. 

Here are some important steps for making your financial goals possible:

Reevaluate Your Budget

First, you will want to analyze your current budget to see how much money you are bringing in each month and how much you might be able to put towards paying early. Look closely at whether you can rearrange your budget a bit to have more money to put towards debt payments. Are there expenses you can temporarily reduce? Create a new budget based on your findings and allocate a base of what you will put towards paying off your car or your personal loan each month.

Minimize Unnecessary Spending

Once you have that new budget, review it to see if there are unnecessary expenses you can cut altogether. Some expenses qualify as wants rather than needs. If something is not a necessity, it might be a good idea to cut that expense and reallocate it towards your loan balance. Stop ordering delivery for a while or cut the HBO Max subscription for a couple of months. You’d be surprised how quickly you can pay off your loan with a few minor sacrifices like these.

Round up Your Monthly Payments

Every time you make a monthly payment, round-up from the amount you usually pay. If you can only round up to the nearest $50 on your monthly installment, this will still speed up the process and help you pay the principal balance down faster, along with the interest payments. This will also work well for other high-interest debt you have, like cash advances and credit card debt. Round up your payment from the minimum payment.

Pay Twice a Month Instead of Once

Another option for increasing how much you put towards your loan each month is to pay twice every month instead of once. Biweekly payments can be an excellent way to keep yourself accountable by ensuring the remaining balance is at the forefront of your mind throughout the month. Paying twice in a month allows you to analyze your budget at the beginning of the month and near the end so you can identify where you have extra cash to put towards your debt. 

Put Financial Windfalls Towards Paying off the Loan

Once in a while, we get hit by an unexpected financial windfall. This could look like a bonus at work or an impressive tax refund. A happy surprise like this will usually go to treat yourself and rightfully so. Typically, you might want to get yourself a spa weekend or a new tech gadget. However, this is the perfect opportunity to take advantage of when paying off a loan early. 

Resist the temptation of spending that windfall just this once and put it towards your personal loan or paying off your car. When you have one less financial obligation to worry about and you save money on interest, you will not regret it.

Bring in Extra Income

Now is the perfect time to ask for that raise at work or to launch your side hustle project. Increasing your income is the perfect way to pay off your loan exponentially faster than you would be able to with your income as it is now. If you aren’t due for a raise, look into taking on a second job for just a couple of months. Some common side hustles that are perfect for increasing your cash flow include dog walking, food delivery apps, or ride-hailing services.

References:
What Happens If You Pay Off A Personal Loan Early? | CNBC
Pros and cons of paying off a car loan early | Chase Auto