Here's What Happens When You Repay a Personal Loan Early

There's a reason personal loans have become such a popular borrowing option, as evidenced by the 23.5 million consumers who had one as of the fourth quarter of 2023, according to TransUnion. With a personal loan, you can borrow money for any purpose, whether it's to fix up your home, go on vacation, or start a business. And once you put that loan in place, your interest rate on it is fixed, so you won't have to worry about your payments going up.

You may sign a personal loan that has you repaying the balance over several years. But what if you end up in a position to pay off that loan ahead of schedule?

Perhaps you've gotten a small inheritance that could satisfy your loan balance. Or it could be that you got a new job with a notably higher salary, and with careful budgeting, you can make higher payments to get your balance paid down sooner than planned.

You may be tempted to repay your personal loan early to save money on interest and just plain shake that debt. But while doing so might work to your benefit, you might face a surprising pitfall.

Will you be penalized for paying off a personal loan early?

Some loans, including personal loans, come with a prepayment penalty. As the name suggests, this is a penalty that applies when a loan is paid off ahead of schedule.

Why would a lender impose a prepayment penalty, you ask, when it means getting its money back sooner? The reason is that lenders make money by collecting loan interest. So the sooner you pay off a loan, the less interest your lender stands to take in.

Meanwhile, there can be costs and administrative work associated with putting a personal loan in place on your lender's side, so it may only want to put in that effort to make a certain amount of money on interest. If you cut that amount by repaying your loan early, you might face a penalty.

Now that said, it's not a given that your personal loan will have a prepayment penalty clause. To find out, you'll need to check your loan documents, which you should have been given a copy of. You may find that your specific loan doesn't charge a prepayment penalty, which means you're off the hook.

Otherwise, find out what that penalty amounts to and run the numbers to see if your savings on interest will outweigh the penalty. If you're looking at a $100 prepayment penalty but you stand to save $600 on interest, then clearly, moving forward with an earlier repayment date still makes financial sense.

Make sure you don't need the money for something else

The idea of shedding your personal loan debt may be appealing. But before you take your extra money and use it to repay your personal loan early, make sure you don't need that cash for another purpose.

For example, if you don't have enough money in your emergency fund to cover at least three full months of essential bills, you may be better off putting your extra cash into savings instead of your personal loan. And if you owe money on a credit card charging 18% interest while your personal loan only charges 8%, then you're probably better off using your cash to chip away at your credit card balance first.

All told, repaying a personal loan may or may not cost you in terms of a penalty. The only way to know for sure is to read your loan document carefully and find out what's in store.