Financial products are the most heavily marketed products on the planet because they have such a high profit margin. Banks borrow money at 1 to 3 percent and loan it out at anywhere from 4 to 40 percent. The interest rate includes the loan administration costs and the losses from those that default on the loan, but a large percentage of it is profit. And you’d do better in life if you paid off your loans early and started saving up for what you need instead of borrowing money for your next purchase. Here are a few tips for those who want to pay off personal loans early.
Know the Rules Before You Apply for the Loan
Can you pay off personal loans early? Most loans can be paid off early, though there may be a prepayment penalty, as stated by matchfinancial.com. For example, some mortgages are closed. They may prohibit you from paying down the principal, though most will simply limit how much you can pay against the principal and when you can do so. Others charge you a fee to offset the interest they lose if you pay extra toward the home loan. Credit cards don’t have that type of limit, though they may push you to use it by charging an annual fee if you don’t charge more than a given amount each month.
What about unsecured loans? Lenders may charge you a lower interest rate if you sign up for a loan that charges a penalty if you pay it off early. They do this for the same reason mortgages may charge a penalty proportional to the interest payments they’re losing – to guarantee their profit margin. How do you avoid these prepayment penalties on an unsecured personal loan? Research the terms and conditions of the loan before you sign up for it. If they charge you a penalty for prepaying the loan, you can choose another financial product.
Run the Numbers
What should you do if you’ve already taken out a loan that charges a prepayment penalty if you pay it off early? Run the numbers. Would you actually save money if you paid off the loan early? The answer is yes if the prepayment penalty is less than the interest you’d pay over the remainder of the loan. However, that may not mean that paying down that particular loan is the best use of your money.
For example, would you save more money over the long term if you used that money to pay down credit card debt? You might want to save the money in an emergency fund instead, too. While that account doesn’t generate anything in terms of interest, it could be worth it if the savings allow you to pay for future expenses with cash instead of borrowing money at 10 to 20 percent for the next major expenditure.
Get on a Budget
Personal finance is ninety percent personal, ten percent finance. You can’t get out of debt unless you get control of your money. And the best way to do that is to make a budget. How much money do you have coming in every month? How much money is going out every month in regular bills? This category includes rent, utilities, phone bills, car payments, childcare, and taxes. How much do you have left over after the essentials? If the answer is zero or negative, you can’t get out of debt until you make dramatic lifestyle changes. This could include anything from moving to a smaller apartment to requesting additional child support to changing childcare providers. Or you may have to stop shopping at the expensive organic grocery store and buy generic brands at the grocery store. For some, the solution is canceling the unnecessary line items coming out of the paycheck at work. Stop contributing to the retirement plan when you’re paying 30 percent interest on debt. Don’t pay for unnecessary cancer insurance through work. Don’t assume that the life insurance and auto insurance your employer offers are the best deal. And you may be better off reducing the amount of coverage you have or increasing your deductible, so you have more money to pay your bills.
Suppose you have some discretionary income. Compare all of the optional and ongoing bills you have that fall into this category. How much are you spending on eating out and evenings out? How much are you spending on apps, games, and streaming media? If these expenses exceed what you have available in discretionary income, start canceling subscriptions and finding cheaper ways to have fun. Cancel the gym membership and start running in the park.
The goal is to have at least ten percent less going out than coming in. This gives you margin to pay for a higher than average electric bill or grocery bill. The first month you have this extra money, save it, so that you can use it to pay unplanned expenses.
Use Your Extra Cash to Pay Off Debt
We’ve already addressed the need to get on a budget and use the first month’s savings to create a starter emergency fund. The next month, you should use this additional money to pay down your highest-interest debt. If the debt is too large to feel like you’re making progress, then use that money to pay off a little debt. When you wipe it off the books, it feels like an accomplishment, even if it is a little medical bill or ex-partner’s phone bill you were reluctant to pay.
Use any and all additional cash to pay off debt. This could be rebates from electronics purchases, financial gifts from relatives, a tax rebate check, or a deadbeat friend finally paying you back. Use this money to either pay off your debt early or add to your emergency fund. Only reward yourself after you’ve eliminated a debt. Then you won’t reward yourself by spending windfalls of cash as if you deserve something for receiving it.
One way to maintain momentum is to create a list of debts that you post on your refrigerator and/or track on your phone. Check it regularly and make a big deal out of striking something off your list. This may help you avoid splurges and extras when the goal is to pay off your debt early.