Should You Repay Your Personal Loan Early?

By Michael Strauss

It's nearly always desirable to reduce your overall levels of debt, and if you find that you have some surplus funds available you might be tempted to clear a personal loan that you've been making monthly payments on. This sounds attractive, as it'll reduce your outgoings and make your financial life less complicated, but before you decide on this there are a few things to consider, as it's not necessarily the most effective use of any spare cash you have.

Early Repayment Penalties

The first thing to consider is whether your loan agreement actually allows early repayment. The vast majority do, but as lenders make their money by charging interest over the full term of the loan, most aren't too happy to see you leave. Because of this, many loan deals will include an early repayment penalty, also known as a settlement fee.

This charge is usually a percentage of your outstanding balance, and if you still owe quite a bit on your loan then it can work out to be quite expensive. Check your loan agreement, and if there is an early repayment charge then do the maths and see if early repayment still seems like a worthwhile idea.

Credit Card Debts?

Even if there's no settlement fee, most personal loans have a fairly good interest rate or APR, especially when compared to other forms of unsecured debt such as credit cards. If you have such debt, on which a higher interest rate is being charged, then it'll probably make more sense to clear the more expensive debt first, or at least reduce it as much as you can.

Investment

With recent rises in interest rates, there are some great high interest savings deals available, and you may find that investing your surplus funds will provide a greater profit than repaying your loan, especially if repayment penalties or settlement fees are part of the picture.

The final thing to consider is whether repaying the loan will stretch you financially, leaving you with little leeway should an unexpected expense crop up. Leaving yourself short of a little 'rainy day money' could cost you dearly if you're later forced to take out more credit, which could well be more expensive than continuing with your current loan.

So, the four questions you need to ask yourself before deciding on clearing your loan are:

• Will I be charged a hefty settlement fee?
• Have I got any more expensive debt could pay off instead?
• Could I see a better return by investing my money?
• Will repayment leave me with anything in reserve?