Here's What Happens When You Pay Off a Personal Loan Early

There's a reason personal loans are a popular borrowing option. With a personal loan, you can borrow money for any purpose, whether it's to fix up your home or start a business.

As of the first quarter of 2023, U.S. personal loan balances came to $225 billion, according to data from TransUnion. And the average borrower had almost $11,300 in personal loan debt. So if you have one of these loans, you're in good company.

But you may be eager to pay off your personal loan early. Doing so could save you money on interest. But there are a couple of less favorable consequences that could ensue, so it's important to know what to expect.

The upside of paying off a personal loan early

The sooner you pay off a personal loan, whether by applying a lump sum payment to your loan's principal or increasing your monthly payments steadily, the less you stand to spend on interest. That's a good thing.

Let's say you sign a five-year, $10,000 personal loan at 7% interest. If you pay an extra $100 a month on your loan, you can save yourself about $719 on interest compared to sticking to your regular payment schedule. That's money you can spend on a host of other things, from bills to leisure.

The downside of paying off a personal loan early

You can reap some savings by repaying a personal loan ahead of schedule. But some personal loans impose a prepayment penalty for going this route. To see if yours does, check your loan documents.

Now, it may be the case that the money you stand to save on interest will well outweigh the prepayment penalty you'll face for an early payoff. So you'll need to crunch the numbers.

Also consider the mental benefits of paying off a personal loan early. Some people hate the idea of carrying debt and find it stressful. If you're in that boat, it may be worthwhile to pay off your personal loan early even if your prepayment penalty virtually wipes out your interest savings.

Another thing to consider is that paying off a loan early can sometimes cause your credit score to dip temporarily. This may seem counterintuitive at first. After all, why would shedding debt be considered a negative event from a credit standpoint?

But one factor that's accounted for in your credit score calculation is the length of your credit history. If you close out a personal loan, it might shorten the length of time you have your credit accounts open on average, resulting in what should be a fairly modest but nonetheless annoying hit to your credit score.

All told, paying off a personal loan early is generally considered a good thing. And often, the savings you stand to enjoy will outweigh the negatives. But it is important to consider the drawbacks of an early payoff just in case they're significant enough to deter you from paying off your debt ahead of schedule. And even if they don't deter you from an early loan payoff, you should at least know what consequences to anticipate.