Getting rid of as much debt as you can is always a good idea, and most budgeting plans will tell you to do this. If you have some extra money, you might be tempted to pay off your personal loan early. Almost all loan plans let you pay off the loan in full before the term is up. But there are a few things to think about before you decide if paying off your loan is the best way to spend your extra money.
First of all, lenders make money by charging interest, and if you pay off your loan early, you won't have to pay as much interest to the lender as you would if you let the loan run its full term. Obviously, this means that they will make less money off of you. To make sure that they still make money if you pay off the loan early, many lenders will include a penalty in the loan agreement.
This repayment penalty, which is also called a redemption charge or a settlement fee, is usually calculated as a percentage of the remaining balance when you pay off your loan. Depending on how early you are in your repayment schedule, this could be a very large amount. Check the fine print of your credit agreement to see how much you could be charged, and see if this makes the idea of paying off your debt early less appealing.
If the fee is high, you might be better off using your extra money for something else that will save you money.
Most credit cards and other types of debt will have higher interest rates than a personal loan, so it may be better to focus on paying off these first. By paying off your debts with the highest interest rates first, your extra cash will help you the most.
Even if you don't have any other debts, you may find that there's a better way to use your extra cash than to pay off a loan with a high settlement fee. Investing in a high-interest savings account or bond over the remaining term of your loan may earn you more in interest than the cost of a redemption charge, but make sure to take into account any taxes you'll have to pay on your investment return when figuring this out.
Lastly, don't forget how important it is to have a little money saved up. If paying off your loan would leave you with very little money left over, an unexpected expense could put you back in the red. If this meant you had to get a new loan, it could end up costing you more than letting your current loan run out for its full term.
To sum up, it's a good idea to pay off your loan, but before you do, you should make sure that a settlement fee doesn't make early payment too expensive, that you couldn't use the money to pay down more expensive debts, and that paying off your personal loan won't leave you with too little money and put you at risk of going back into the red.
