As you likely already know, installment loans must be paid off, usually with monthly repayments, so what exactly happens when I pay off my installment loan early?
When extra money is given to you unexpectedly, such as a bonus from work or tax returns, it can be tempting to make larger monthly repayments than the monthly payment amount in order to pay off the loan early.
Since the loan must be repaid in full, with interest, what are the reasons you should or should not pay it back early?
Pay Off My Installment Loan Early: Consequences
First, let’s discuss the potential consequences of paying off an installment loan early.
Repayment Penalties and Fees
The biggest drawback to paying off a loan before the term ends is the lenders may charge a fee or have a penalty.
When lenders give out loans, they are expecting to make revenue on the interest from the loan, so if someone were to pay off their loan early, this costs them revenue since there would be less interest and revenue accrued. Thus, they tend to have repayment penalties to protect them from losing revenue.
If possible, before ever taking out a loan with a lender, ask them about their repayment policies and terms. If they do have any fees or penalties for paying back the loan early, try to get the penalties removed from your loan agreement prior to accepting the loan.
If you already have an installment loan, carefully read the agreement of the loan and contact your lender to ask about the repayment terms before paying the loan off early. You want to ensure that paying off the loan early will not hurt you in the long run.
Similar to a fee for paying off a loan early, there are often other penalties, such as worsening your credit score. Your score could drop a few points, but it is possible to build up and repair your credit again to maintain a good credit score.
Credit scores are composed of multiple factors that determine your score:
- Credit mix
- Payment history
- Credit utilization
When you pay off a loan early, you lose one of the loan types in your credit mix, which reduces the diversity of your loans, thus, lowering your score.
Because the loan would be repaid over multiple months, it improves your credit score by building up a positive payment history when paid on time. When you pay off the loan early, there are fewer times that the payments are made on time and in full.
If you have other loans with high outstanding balances, it would be best to lower these amounts rather than make extra payments on the personal loan because these can equal a low credit utilization ratio.
Pay Off My Installment Loan Early: Benefits
The largest benefit to paying an installment loan off early is obvious: You are no longer in debt for that loan. Because installment loans are closed-ended credit accounts, as soon as the loan is paid back in full with whatever interest was accrued, the account is closed.
If you know the repayment fee amount in your loan agreement, it would be smart to calculate how much interest would end up charging you over the amount of time left the loan has. If the fee is less than the accrued interest, and you can take the hit to your credit score, this could be a good option.
Paying off a loan early can relieve some monthly financial stress, save money on interest, and reduce your debt-to-income ratio. However, it can also create a repayment fee and temporarily decrease your credit score.
Ultimately, the choice is yours. You should talk to a financial professional, including your lender, before deciding and accepting a loan if possible.
Need More Advice?
As you can see, there are benefits and consequences to paying off an installment loan early. This can be confusing for some people, which is why our team of professionals is here to help!
If you’re asking, “should I pay off my installment loan early?” don’t hesitate to contact our team at Cash Link USA for help organizing your financial affairs!