Dos and don’ts of prepaying your personal loan
Personal loans are the fastest growing type of consumer debt. They can be an effective way to consolidate other forms of debt or pay for an unexpected expense, like expensive home improvements or auto repairs.
In fact, more than 20 million consumers have a personal loan. If you are in the row, you may be able to prepay your personal loan, using the government stimulus check or money you’ve saved by cutting other areas of your budget, like fuel or entertainment.
Before you decide to prepay your loan amounts, consider these personal loan dos and don’ts.
Make sure you can cover your monthly payments
Make sure your budget can cover essential expenses, like housing, utilities, and groceries. You will also want to stay up to date on other loan amounts, especially mortgages or a car loan. If you fall behind on secured loans, you could risk losing your home or automobile. Make sure you can cover those bills and still have money to pay off the personal loan.
Don’t empty your savings account
If you took out the personal loan due to an unforeseen expense, you will want have an emergency fund in place, so you don’t end up in a similar situation later on. It can be nice to pay off a loan sooner, but if you lose your annual income or have some other unforeseen emergency, having extra money in your savings account could be better for your personal finances. A good rule of thumb for building an emergency fund is to save three to six months of expenses. In today’s uncertain economy, paying off a personal loan, especially an unsecured loan, may not be the most critical need for your available funds.
Check the terms of your loan
Understand the terms and requirements of your personal loan if you plan to prepay the debt. Some lenders charge a fee for prepaying your loan to make sure they get the benefit of your loan. You will want to confirm that this is not the case. If your loan has this term, visit Credible’s personal loan calculator to determine how much interest you could save by paying off the loan before its due date. Then compare that to the penalty you incur in deciding if it’s still the right decision.
Do not tap into retirement to repay a personal loan
The average personal loan has an annual interest rate of 6-36%. If yours is on the high end, you may be considering withdrawing money from your retirement savings to pay it back. Before cashing in any of your funds, think about the consequences. Retirement accounts have an age requirement for make withdrawals. If you take funds earlier, you could incur hefty penalties. And with today’s volatile market, you can sell investments for less. You can also consider suspending your pension contributions and using the money to pay off your personal loan. Your loan is not an investment that will pay off in the future. It may be better to stay the course and pay off your personal loan with other forms of cash.
Have a plan for the extra money
Pay off the debt feels good, and you can use the money you’ve freed up by eliminating a monthly payment to meet other financial goals. Maybe your dream is to buy a house? Or maybe you want to pay off other loans and get out of debt? If you have other forms of credit, you can use the snowball method pay something else, taking the amount you paid on the personal loan and applying it to another bill. It could help build credit and your credit score may even improve when you reduce your credit card debtespecially if your personal loan was large. Use the momentum you feel and apply it to your next goal. It’s important to improve your credit score and make sure you have a solid credit history for loan approval, whether you’re looking for a mortgage or beyond.
Paying off a personal loan early can be a good choice if your personal finances are secure. It takes discipline and hard work to pay off debt sooner. Make sure to celebrate the victory. And if you need more advice, consider bringing in a financial advisor.