Is it a good idea to pay off a loan early?
Key takeaways
You can make early loan repayments to save on interest
You are likely to face a penalty fee for paying off a loan before the agreed term ends
Early repayment charges can apply to personal loans and mortgages
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 depends on the charges a lender applies, compared to the interest you would have paid. Often, the earlier you can pay off the loan, the more money you will save.
Am I allowed to pay off a loan early?
Yes, you should be able to make early loan repayments, but you may incur a penalty charge.
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.
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 figure. This is a single, final amount that settles the loan completely, and it will include:
The remaining balance on your loan
Any interest due up to the settlement date
Any early repayment charges or fees that apply
A breakdown of what you’ve already paid, so you can see how the figure is calculated
Once you’ve received your early settlement amount, you’ll have 28 days to decide whether or not to 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.
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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 – so you would still be better off.
Are partial repayments treated differently to paying off the loan early and in full?
Yes, partial repayments and full early repayment are treated differently. Partial repayments, often called overpayments, let you pay extra toward your loan without closing it.
They usually reduce the outstanding balance and the total interest you pay, but your monthly payment may stay the same unless the lender recalculates the schedule.
Full early repayment involves paying off the entire remaining balance at once, usually via a settlement figure. This closes the loan account and may trigger early repayment charges, depending on your agreement.
Always check your lender’s terms before making either type of repayment.
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:
Refinance
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.
Reduce the loan term
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.
Increasing repayments
In most cases, you can’t formally change your agreed monthly repayments once your loan is set up. However, many lenders allow overpayments, which means paying more than your required monthly amount.
Overpaying – either by increasing what you pay each month or making one-off extra payments – can reduce your balance faster, shorten the loan term and cut the total interest you pay.
Check your lender’s terms first because:
There may be limits on how much you can overpay each year
Early repayment charges could apply if you exceed those limits
If you want to make regular overpayments, it’s best to arrange this with your lender so the extra amounts are applied correctly to your loan.
What are the advantages and disadvantages to early loan repayments?
Paying off a loan early can be a smart financial move, but it’s not always the right choice for everyone. Here are the key pros and cons to consider.
Pros
The sooner you repay, the less interest you’ll pay overall
Clearing the loan early can improve your financial situation and peace of mind
With one less monthly payment, you may find it easier to manage your budget or take on other financial goals
Cons
Some lenders apply early repayment charges that could reduce or outweigh your savings
Using savings to clear a loan could leave you short of emergency funds
Your money might achieve better returns elsewhere, such as in savings or investments
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.
By paying off your loan early, you’ll be closing the loan account, but sometimes potential lenders like to see that you’re clearing your debt over time in monthly repayments as it shows you’re managing your money well.
That said, 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 and it is hard to put a value on the peace of mind you achieve from clearing a debt.
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 and whether it’s the right choice:
Car finance
Whether you can repay early depends on the type of agreement you have – such as a personal loan, Hire Purchase (HP), or Personal Contract Purchase (PCP) – as each is treated slightly differently.
For a standard car loan, most lenders allow overpayments or early settlement, although you may face an early repayment charge. You’ll usually need to request a settlement figure, which shows the total amount needed to clear the loan in full.
With HP, you also have the right to settle early. You can ask for a settlement figure at any time, and in some cases you may be entitled to a partial interest rebate.
There may still be fees, so it’s worth checking your agreement. For PCP, early repayment is possible but can be more complex.
You can settle early by paying off the outstanding finance, including any remaining payments and the optional final ‘balloon’ payment.
Alternatively, you may have the right to voluntarily terminate the agreement once you’ve paid 50% of the total amount payable.
In all cases, the best first step is to contact your finance provider and ask for an early settlement figure. This will confirm exactly how much you need to pay, including any fees or interest, to clear the agreement.
Mortgage
You can usually repay your mortgage early, but it depends on your lender and the terms of your deal. Most mortgages allow overpayments or full early repayment, but you may face early repayment charges, especially during a fixed or introductory period.
These fees can be significant, so it’s important to check your agreement first. Once any deal period ends, you can typically repay more freely without penalties, helping you reduce interest and clear your mortgage sooner.
Student loan
You can repay your student loan early in the UK, but it’s not always the best financial decision. Repayments normally depend on your income, and any remaining balance is written off after a set period. Because interest rates can be relatively high, paying early may reduce the total cost.
However, if your income stays below the repayment threshold or you expect part of the loan to be written off, overpaying could mean losing money unnecessarily.
Before making extra payments, consider how much you might earn in the coming years, other financial priorities, and whether your money could be better used elsewhere, such as savings or investments or a deposit for a first home.
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 if you pay back the loan early and they don’t get the full amount of interest, some of their projected turnover is protected.
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 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.
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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Author
Tim Heming
Personal Finance Expert
Tim Heming is a journalist and editor who has written about personal finance for national newspapers and consumer websites for 15 years. Tim enjoys providing no-nonsense information to help consumers...
Reviewer
Rebecca Goodman
Personal Finance & Insurance Expert
Rebecca is an award-winning financial journalist with over a decade of experience writing for print and online media. Her mission is to take the jargon out of personal finance and to help everyone...
