Acquiring a loan is inevitable. Everyone will need extra cash at least once in their life. It’s normal to have debt. What’s important is how you manage these debts by being responsible for your repayment obligations.
Most people even believe that paying a loan early is a good thing. Although it is, you must also remember that it also has some disadvantages. Let’s discuss the benefits and drawbacks of paying your loan early to know what to avoid.
The Benefits Of Paying Off Your Loan Early
Paying off your loans early is highly encouraged, especially by lenders, as it can give you a series of benefits like:
You Can Save On Interest
The longer your loan is active, the more you’ll pay for its interest rate over time. It doesn’t matter what kind of loan you acquired, whether it is quick loans online or a personal loan from a traditional brick-and-mortar lending company.
This benefit will be better enjoyed by individuals with a longer loan term. Paying early can make a significant difference, even for months or years.
Lowers Debt-to-Income Ratio
A debt-to-income ratio or DTI is your monthly loan repayment divided by your monthly income. This number is one method lenders use to determine your capacity to handle the regular payments necessary to pay back the money you plan to loan.
It is known that borrowers who have low debt-to-income ratios are more likely to manage their monthly debt payments successfully. As a result, banks and financial credit providers prefer to look for low DTI percentages before making a loan offer or approving a potential borrower.
If you lower your DTI, lenders, banks, and even investors will see you as a responsible borrower. You will become an asset to them and not a liability, which means you’ll be able to get a loan faster and easier next time.
Offers Financial Freedom
As per the Finder’s Consumer Confidence Index, 75-77% of Americans believe they are stressed about their present financial condition. It’s safe to assert that debt is a major contributor to this financial stress.
You may get peace of mind by paying off a personal loan early. Additionally, you might have more money toward long-term financial goals now that your monthly loan payments are no longer an expense.
The Drawbacks of Paying Off Your Loan Early
Many people believe that paying off your debts early only benefits you. But on the contrary, it can also bring some drawbacks, such as:
Paying Early Can Hurt Your Credit Score
You read that right. Contrary to what many people believe, paying your loan in advance can hurt your credit score, at least temporarily. However, credit bureaus consider multiple factors in assessing your scores, such as credit mix, credit utilization, and payment history.
Paying off your debt early means you lose the chance to build your credit as you only have a short payment history. Moreover, paying off a loan will remove it from your credit mix. As a result, your credit score will decrease due to a lack of variety on your credit record. Any decrease in your credit score due to paying off a loan in advance will only be temporary and minimal.
Paying Prepayment Penalties
Another thing to consider that is a drawback in paying a loan early is the prepayment penalty. A prepayment penalty is a fee that lenders require you to pay if you settle a part of the full amount of your loan early.
All loans have their respective terms and conditions, especially regarding the time to repay the loan. Most commonly, lenders offer a loan term with a minimum of 3 years and a maximum of 6 years or more. That’s why it’s highly advised to read the loan terms and conditions before you accept an agreement with a lender.
Check if the lender where you’re applying for a loan imposes a prepayment penalty and how much you must pay. This way, you can plan if you’re thinking of paying your loan in advance.
You Can’t Make Use Of the Fund Elsewhere
When paying off a debt early, you’ll utilize the extra money you have on hand. Keep in mind that paying off a loan early will require you to have a huge amount of money.
You must consider using your extra cash for other purposes, such as starting a side business or purchasing stock in a corporation. Plus, you can avoid the drawbacks of paying a loan in advance. Instead, you are putting your money in a place where it can multiply. You cannot only afford to pay your debt but also have an extra income.
Even though paying off a loan earlier than the agreed schedule sounds responsible, you must still consider its drawbacks, too. Therefore, think twice about whether paying off your loan will be advantageous or not.