Paying off a personal loan early

Paying off a personal loan early may seem like the logical and responsible step to make, if you have the savings available. However, it is important to think about the extra costs you can incur in doing so. Some lenders will require an early repayment charge to be paid in order to settle your debt. This could cut into the money you are saving by ending your loan agreement early. In this article we will explain how paying a loan off early works, the savings you can make, what obstacles might get in your way and what extra fees and charges you may need to pay.

Can you pay a loan off early?

Yes. Under the Consumer Credit Act, you are entitled to settle your personal loan at any time. Alternatively, you also have the right to pay more than the agreed monthly amount in order to clear your debt sooner. Keep in mind that both of these options may be subject to an early repayment charge (ERC).

To pay a loan off early in full, you will need to ask your lender for an early settlement figure. This includes the amount of money you still need to repay plus any interest or fees that are still owed. Once you have the figure, you can pay your lender and clear your debt, or you can choose to continue with your current repayment schedule – there is no obligation to repay the loan just because you have asked for an early settlement figure.

If instead, you want to partly pay a loan off early, the process will usually work in a similar way. You will need to contact your lender to tell them how much you want to pay off and ask how this payment will affect future payments. Paying off a chunk of your loan can either reduce the term of your loan or decrease your monthly payments – your lender should tell you how it will affect your loan. Some lenders will allow you to pay off part of your loan online without needing to contact them.

Whichever way you choose to pay off your loan early, the fees and charges should be listed in the loan agreement you received when your application was approved.

Paying off a loan early through cancellation

There is a 14-day ‘cooling off period’ after you take out a personal loan, during which you can cancel your loan. If you choose to cancel, you will then need to repay the money you received within the timeframe set out by your lender, but you should not be charged any interest or additional fees.

How to pay off a personal loan early

Here are the simple steps to follow in order to clear your debt early:

1. Contact your lender - Tell your lender you want to pay off your loan early and request a settlement figure.
2. Assess your early settlement figure - Check if your lender demands an early repayment charge. If it does, assess if it is a fair amount and if you are saving enough money from ending the agreement early to balance out the extra fees you have to pay.
3. Make a decision - Decide if you still want to go ahead with paying off your loan. You still have the option to continue with the existing arrangement or change how much you are going to pay back.
4. Make the payment - Your lender will set out how long you have to repay the loan once you receive your early settlement figure, usually 28 days. If you do not make the payment in this timeframe, the lender will likely need to recalculate your early settlement figure.

How to make an overpayment

Instead of paying off a personal loan early, borrowers can choose to make a partial payment. Here is how:

1. Check if you can make a payment online - Some lenders allow borrowers to make lump sum payments online or through an app.
2. Contact your lender - If you cannot make a payment online, you will need to contact your lender and state that you plan to pay off part of your loan. Make sure to specify how much you want to pay.
3. Consider your lender’s response - Your lender should lay out how your repayments will change once you have made your partial repayment. Some lenders will keep the amount you pay each month the same, but reduce the number of months you need to pay it for. Other lenders will reduce your monthly payments, but keep the loan term the same. Make sure you are happy with how your repayments will be structured moving forward.
4. Make the payment - Most lenders will give you 28 days to pay the agreed amount. If you miss this deadline, the lender will recalculate how much you need to pay.

Should you pay a loan off early?

Whether or not you should use available cash to clear your personal loan debt will depend on how much interest you are paying, what return you are able to get on your savings and your attitude towards debt – there is no one answer that will suit everyone.

Even if you decide not to pay off your loan early, you could ask for an early settlement figure to get a better understanding of the costs involved. There is no requirement to pay off your loan just because you have requested an early settlement figure, though you will usually have a limited time to accept it. Once you know how much it will cost you to pay off your loan early, you can decide whether the best option for you is to clear your debt, stick to your current loan agreement or pay back part of what you owe.

Early loan repayment FAQs

If you cannot decide whether to pay off all of your debt, part of it or none at all, there are a few simple questions you could ask yourself to figure out the best course of action:

• How much will you save if you pay your loan (or part) off early?
• Will the early repayment charges be more or less than what you would pay in interest by sticking to the current repayment plan?
• Would paying off your personal loan leave you without any savings for emergencies?
• Do you have any other debts that need to be prioritised over your personal loan (eg. high-interest credit cards, overdue rent, council tax bills)?

Does paying off a loan early hurt your credit score?

Paying off a loan on time and consistently over many months is a good indication that a borrower is reliable and responsible. By paying off a loan early, you are giving up the opportunity to have this recorded on your credit file and your credit history with that lender will be limited. While it may seem that paying off a loan early is a good example of someone in control of their finances, as it will likely save you money, it can have a negative effect on your credit score.

Thankfully, any negative effects should be short term and minor, and unlikely to outweigh the benefits of saving money and clearing your debt. If you want to improve your credit score, check out our article 'How to improve your credit score quickly'.

What is an early repayment charge (ERC)?

The rate of interest that a lender applies to your loan is based on the expectation that you will pay it back steadily over the course of the loan term, allowing the interest to compound and grow. The more interest you pay, the more money the lender gets. If you opt for an early loan repayment, you are stopping the interest from compounding and so saving yourself money, but cutting the revenue made by the lender. To redress this balance, your lender may expect you to pay more than just what you owe in order to clear your debt early.

Some lenders will charge borrowers a fee for repaying their debt early on top of a portion of the total interest. Lenders may refer to one of these figures, as well as the combined total cost, as an early repayment charge. To clear up any potential confusion, make sure to read your loan agreement carefully to see how your lender specifies an ERC.

How to calculate an early repayment charge

The exact amount it costs to pay off a loan early will depend on two key factors – how much you still need to pay back and how long is left on the loan term. The Consumer Credit Directive states that there can be no penalty fees to fully or partly settle a loan with payments of up to £8,000 a year, if that loan was taken out before February 2011. If the payment exceeds £8,000, a lender can charge 1% of the amount repaid early if there is more than one year left on the loan term or 0.5% if there is less than one year left. With interest charges, lenders can charge up to 28 days worth of interest if your loan term was less than 12 months or 58 days’ interest if your loan term exceeded 12 months.

Pros and cons of paying off a loan early

Here are the main costs and benefits to weigh up when you consider paying off a personal loan early:

Pros of paying off a loan early

• Pay less in interest - Paying off part or all of your loan early means you will avoid having to pay as much interest as if you had stuck to the original plan.
• Debt free earlier - Paying off your loan earlier will leave you with more money each month that you put towards savings goals or repaying other debts.

Cons of paying off a loan early

• Early repayment charge - It is important to make sure that any early repayment charge you pay does not cancel out the benefits of paying your loan off early.
• Interest charges - Some lenders will not label the fee you pay as an early repayment charge, but you will still need to pay a certain amount of interest to clear your debt.

How to complain about an early repayment charge

If you think you have been charged an unfair early repayment charge or the amount is higher than what is in your loan agreement, you can complain. You should always have the option to refuse your early repayment charge and continue to pay back your debt as originally agreed. Alternatively, you can complain in writing to your lender. If the issue is not resolved, your next step should be to contact the Financial Ombudsman Service. This is a free, independent organisation that has the authority to resolve certain disputes between aggrieved borrowers and their lenders.