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Most personal loan lenders allow borrowers to pay off their loans early, without prepayment penalties. But before you dip into savings or use an influx of cash to pay off a loan, make sure all your financial bases are covered.
Understanding your financial goals — and where loan payoff falls among them — will make managing your loan easier.
Here are five do’s and don’ts to keep in mind if you’re tempted to pay off your personal loan early.
Do prioritize monthly expenses first
Your monthly expenses — things like rent, utilities and groceries — are what you need to live. But also consider debts like credit cards and student loans as essential payments that you can’t skip, says Kayse Kress, a certified financial planner and owner of DocsFP.
“Whoever you owe money to, those are fixed payments,” she says. “That’s just part of your living expenses that you have to pay.”
Auto loans and mortgages are often secured by your property, and you shouldn’t risk losing your car or home to make an extra payment toward an unsecured loan.
Kress says skipping a debt payment here and there can become a bad habit, so she generally recommends against it.
Do set aside savings
Prioritizing an emergency fund before extra personal loan payments can keep you financially secure if a surprise expense crops up, says Tara T. Unverzagt, a California-based certified financial planner at South Bay Financial Partners.
Your savings protect against worst-case scenarios, like losing your job, a medical emergency or home repair. One rule of thumb for emergency savings is to keep three to six months’ expenses on hand.
Unverzagt says taking a small amount out of savings to send a final personal loan payment a month or so early is fine. Just avoid withdrawing so much or so often that you’re left vulnerable in an emergency, she says.
Do know if your loan comes with prepayment fees
Prepayment fees ensure lenders make money off your loan, even if you save on interest by repaying early.
But few personal loan lenders still charge prepayment fees. To be sure, read the fine print on your loan agreement. If your loan has a prepayment fee, determine if it’s cheaper to pay off your loan balance plus the fee or just continue making regular monthly payments.
Don’t rob your retirement to pay off debt
Suppose your retirement account’s rate of return is higher than your loan’s annual percentage rate. In that case, you might consider splitting an extra loan payment between the accounts, an approach that serves both your immediate desire to be debt-free and your future goals.
Personal loans come with APRs from 6% to 36%, while the return on a Roth IRA, for example, depends on the investments you’ve put in it.
Kress recommends paying down high-interest debt before splitting extra cash among investments and debt payments.
Still, “your loan will never send you money back,” she says. So avoid skipping your monthly retirement contributions to make a few extra payments.
Don’t overthink it
Having your monthly budget and safety net in place is a must, says Taylor Venanzi, Pennsylvania-based certified financial planner and owner of Activate Wealth. Beyond that, he cautions against letting the perfect be the enemy of the good.
Paying off a loan with the extra money you have can be a fine decision if that’s what you want to do, even if that money could go toward lowering your monthly payments on something like a credit card.
“There are really good decisions, and then there’s the best decision,” he says. “Sometimes you just have to weigh the mental benefits of getting one [debt] completely gone versus optimizing which interest rate to pay down.”
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