An installment loan allows a person to borrow a lump sum of money upfront. They then repay the principal plus interest every month. When they take out an installment loan, they can follow the repayment schedule they agreed to in their loan agreement and pay it off at the end of their loan term. Or they can repay the loan early.

Is it a good idea to pay off an installment loan early?

While it’s possible to pay off the loan early, the borrower should weigh the pros and cons before they do so.

Pros of an early payoff

The most important benefits of paying off an installment loan early include:

  • Save money on interest: The faster a person repays an installment loan, the less they’ll pay in interest charges. Depending on the loan terms and how quickly they pay it off, they can save hundreds or even thousands of dollars.
  • Free up a monthly budget: Once a monthly loan payment is gone, the borrower will have the extra money in their budget to allocate toward other needs. They may use it to cover everyday expenses or work towards financial goals like building an emergency fund or investing.
  • Lower debt-to-income ratio: A person’s debt-to-income ratio is all their monthly debt payments divided by their gross monthly income. Paying off an installment loan will lower the ratio and, in turn, boost their credit score, making it easier to qualify for loans with excellent terms in the future.
  • Have peace of mind: When someone pays off their loan early, they’ll free themselves of a debt obligation. This can make them feel less stressed about their finances.

Cons of an early payoff

These are the major drawbacks of repaying an installment loan ahead of schedule:

  • May be on the hook for a prepayment penalty: Some lenders charge a prepayment penalty to recover the interest they’d lose if borrowers repay their loan early. In most cases, it’s a set percentage of the unpaid principal balance at the time of the payoff. It’s helpful for borrowers to check their loan agreement carefully to determine if they’ll owe a prepayment penalty. If so, they should do the math to determine if it’s worth paying off the loan early.
  • May have more important financial needs: If the rate on the installment loan is lower than the rates a person has on other debts, they may want to put their money elsewhere. For example, they may focus on paying off their high-interest credit card debt.
  • Will have less cash at disposal: Since borrowers have to put a lot of their extra money toward the loan, they may face a cash shortage. This can be an issue if a financial emergency or other situation that requires ample cash flow strikes.

The Bottom Line

An installment loan is a convenient and affordable way to cover various expenses. But paying it off early isn’t always the best choice. That’s why it’s always best for a person to weigh the pros and cons of doing so before pursuing an early payoff and do what works best for their budget.

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