Is it a good idea to pay off a loan early?
If you choose to pay off a loan early, you could save money on interest charges but you mayface an early repayment charge (ERC). Here’s our guide to early loan repayments and what you’ll need to consider.
Key takeaways
You can make early loan repayments to save on interest
ERCs are penalty fees for paying off a loan before the agreed term ends, these apply to personal loans and mortgages
Lenders charge fees because they lose out by not being paid interest for the full loan term
Paying off a loan early doesn’t always boost your credit score
Can I save money by paying off my loan early?
You may be able to save money if you repay a loan early, it all depends on the charges a lender applies, compared to the interest you would have paid.
Under Consumer Credit Regulations 2004, lenders can charge you up to two months of additional interest if you decide to pay your loan off earlier than planned. If your loan has less than 12 months to run, lenders can only charge up to one month’s interest for early redemption.
Example: On a three-year £10,000 loan at an interest rate of 8%, the monthly interest charge is about £34. If the lender imposes a two-month interest early repayment fee, you would therefore be charged around £70.
But if you repaid the loan after one year, you’d make a saving in interest of more than £800 over the remaining two-year term (based on a three-year loan at 8%) – so you would still be better off.
Am I allowed to pay off a loan early?
You should be able to make early loan repayments, but you may incur a penalty charge.
To find out exactly how much you will need to pay to repay your loan in full, you’ll have to ask your lender for an early settlement amount. This will show you:
How much you’ve paid so far
How much you still owe
What interest charges you’ll have to pay
Any early repayment charges that apply
Once you’ve received your early settlement amount, you’ll have 28 days to decidewhether or notto go ahead. If you decide to make early loan repayments after that point, you’ll have to ask for the early settlement amount to be recalculated.
Whether or not you can make partial overpayments will depend on the type of loan you have, when you took it out, and the agreement you signed with the lender.
Want a better idea of how much your loan will cost you? Check out our loans calculator.
What are the alternatives to paying off a loan early?
Paying off the loan early with money from your savings or current account is not the only way to save money on interest payments. You could also:
Refinancing involves taking out a new loan agreement from a lender with better financial terms and using it to pay off the existing outstanding loan.
You are still likely to face an early repayment charge, but if the new personal loan has a lower interest rate, you may be able to save money overall.
This might be an option if interest rates have fallen since you took out the original loan amount.
Reducing the loan term will increase the amount you pay each month, but you’ll reduce the number of payments and pay less interest overall.
Whether this is an option will depend on the terms of your loan, as lenders may be unwilling to change the initial agreement. While you are likely to face an early repayment charge, you can factor this cost in to decide whether it’s worth it.
Make sure you’re still able to afford the interest payments month-on-month if you reduce the length of your loan. If not, any fees and charges for missed payments will quickly erode any savings you make from paying less total interest.
You may be able to pay off more of your loan by changing your repayments. This can shorten the length of the loan and can save you money in interest.
Not all lenders will allow this so you will need to check with your lender first. There may also be limits on the amount you can change the payments to.
Refinance
Reduce the loan term
Increasing repayments
What are the benefits of early loan repayments?
Paying off a loan early can save you money in some situations. This cash can then be put towards your savings – or another expense – rather than paying it to your lender in interest.
It also means you are reducing the debt you owe, or clearing it altogether, at a quicker rate.
What are the downsides of an early loan repayment?
When you repay a loan early, you need to factor in any early repayment fees you may face.
If, for example, the fee for paying your loan off early is two months' worth of interest, but you have just over a year of interest left to pay, it may not be worthwhile repaying early.
But if you still have many more years of interest ahead, the savings are likely to be greater by paying it off early.
Using our Loan Calculator to work out how much you could borrow and how much it will cost you each month can help you make the right decision.
Does paying off a loan early affect my credit score?
If you have spare cash and you’re looking to pay off your loan early, you might assume this would boost your credit score.
But unlike with credit cards, where if you make a payment your credit score should improve(because you’re reducing your debt relative to your credit limit), making early loan repayments can work differently for your credit score.
When you pay off a loan, your credit report shows the account as closed, and open accounts tend to have a greater positive impact on your credit score as they’re seen as a measure of how well you’re managing your debt.
By paying off your loan early, you’ll be closing the loan account and reducing the diversity of your available credit. Sometimes lenders like to see that you’re clearing your debt over time in monthly repayments as it shows you’re managing your money well.
However, it could still be worthwhile using extra cash to repay your loan early as any negative impact on your credit file is likely to be small and temporary.
Is it a good idea to pay other loans off early?
Here are a few examples of how it may work when repaying other loans or credit early:
Whether you can pay off your car loan early will depend onyour lender and thetype of car finance you have.
For most types of car finance, you’ll need to contact yourprovider and ask for a settlement figure and some loan providers will charge you extra fees if you start making higher repayments than you’ve agreed to.
In other cases, finance providers may haveno problem with you doing so.
You may be able to pay off more of your loan per month to save money, but it will depend on the loan provider and structure of the deal.
For example, you may be able to make an overpayment up to a certain amount, but if you go beyond that it will trigger an early repayment charge. Check the terms and conditions and contact the lender if you are unsure.
Overpayments are often useful because they will chip away at the capital of the loan which should mean you pay less interest in total and can clear your debt more quickly.
Can I repay my car loan early?
Can I increase my monthly payments on a personal loan?
Why do providers charge early repayment fees?
When lenders approve loan applications, they do so in the knowledge they are taking on a certain amount of risk that the loan may not be repaid but should stand to make a profit through the interest repayments.
Because the interest rate and length of the loan is set from the outset, lenders know exactly how much return a single loan should generate. However, if you decide to pay back the loan early – and save yourself additional interest – this cuts into their profit margin.
By charging early repayment charges (ERCs) it means that even if you pay back the loan early some of their projected turnover is protected even if they don’t get the full amount of interest they originally banked on.
Because they are authorised by the Financial Conduct Authority, lenders also have to treat customers fairly, and shouldn’t encourage them to take on more debt than they feel they need.
This means they cannot make early repayment charges so prohibitive that there is no benefit for a customer who is in position to pay a loan off early from taking that option.
Early repayment charges don’t only apply to personal loans. They are also included on other financial products such as secured loans and mortgages, as our guide explains.
Can I cancel a loan once I’ve borrowed the money?
You have a legal right to cancel a loan within a specific timeframe known as the ‘cooling-off period’ in the UK. This period is typically 14 days from the day you receive the loan agreement or a notice informing you that you've been approved for the loan, whichever is later. This right to cancel is granted under the Consumer Credit Act.
To cancel the loan within the cooling-off period, you must notify the lender in writing. You'll need to repay the amount borrowed and any interest accrued up to that point, and any fees incurred. The lender may also charge a daily interest rate for the time you had the loan.
It's essential to read the loan agreement carefully and understand the terms, including the interest rate and any associated fees before you apply.
How much does it cost to repay a loan early?
While paying your loan back before the end of the term may sound like a way to save money, you’ll need to keep an eye out for any costs, such as early repayment charges (ERCs.)
To check if any early repayment charges apply, take a look at the documents you were given when you took out your loan – they should explain if there’s any redemption fee or early repayment charges and how much they might cost you.
With some unsecured loans, you can make overpayments up to £8,000 within 12 months without being charged for it –but this will vary depending on the type of loan you have and your lender’s terms, so check this beforehand.
Personal Finance & Insurance Expert
Our expert says...
If you have the money to pay off a loan early, this can reduce the debt you owe, boost your savings, and save you money in interest payments. However, it’s a bit of a balancing act as if you end up paying more in early repayment fees than you would have paid in interest, it’s not worth it. Look carefully at all of the details and speak to your lender before you decide.
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Just make sure you factor in any early repayment charges on your existing loan and work out if you’d be saving money overall by switching deals.
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