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Checking the Fine Print in Your Personal Loan Contract
Americans have done a good job of cutting down household debt during 2020, but the average U.S. adult still has $26,621 in personal debt, excluding mortgage debt.
Personal loans account for a healthy slice of that debt. According to Transunion, personal loan debt is on the rise.
Here are the numbers, as of the first quarter of 2020:
- The number of Americans with personal loans increased from 19.3 million to 20.9 million
- The total number of personal loans in the U.S. increased from 21.4 million to 23.4 million
- The average amount of personal loan debt per borrower increased from $8,618 to $9,025
- The total balance of personal loans in the U.S. increased from $143 billion to $162 billion
Getting Back to Square
While personal loans can be a big help in consolidating multiple household debts, they are loans that need to be paid back – and the sooner the better.
“Paying down and off a personal loan on an accelerated plan means you will pay less interest over the life of the loan and the lender will have potential claim over your assets (even if it’s just your wages through garnishments for unsecured loans) for a shorter period of time,” says Todd Christensen, founder at MoneyFit, a non-profit financial counseling organization in Boise, Id.
Cutting short your loan term also has another perk. “The sooner you pay off your debt, the less interest you pay over time,” says Timothy Hansen, chief executive officer at Wealth Growth Wisdom, LLC, a money management platform. “In particular, paying off high-interest debt can deliver significant interest savings. Once that debt is gone, you can allocate more money to savings.”
Your credit profile may also be improved by paying down a personal loan more quickly.
“When you pay off a loan, your account is closed in good standing,” Hansen says. “At this point, you have eliminated the risk to your credit score posed by late or missed payments. A paid-off loan can also lower your debt-to-income ratio, a key metric lenders use to make credit decisions. That means if you pay off a personal loan before you apply for a mortgage, you could qualify for better terms.”
Tips for Early Payoffs
How can personal loan borrowers accelerate their debt payments and get back to no debt? Financial experts have a few ideas in mind.
Make extra payments. “One easy way you can pay off your personal loan faster is by making extra payments towards your loan,” says Kalicia Bateman, loan specialist at BestCompany.com. “This can be done by setting extra money aside, or choosing to put any extraneous income, like a work bonus or birthday money, towards your loan.”
Refinance your personal loan. Refinancing can get a borrower lower interest rates and shorten the overall loan term.
“Refinancing results in a new loan with a different lender that pays off your original loan or loans,” Bateman says. “Refinancing is a great option if you have multiple loans that you are trying to pay off because you can combine them into one with lower rates and terms, saving you time and money overall.”
Build a savings budget. A great way to cut the life of your loan is to work on earning more money with the intention of making extra payments on your loan.
“Consider selling goods on Amazon or eBay, cutting your impulse purchases and putting saved money toward your loan, or taking on a side hustle on weekends or holidays for extra cash,” says Hansen. “Even a job that nets you an extra $200 a month can make a big difference in your loan.”
Ask about a prepayment penalty. Ask your personal loan lender if there are any prepayment penalties.
“Prepayment penalties are fees lenders charge to make up for the interest they would have earned, had you continued to pay off the loan according to your original term,” says Anna Serio, a certified commercial loan officer at Finder.com. “If there is a prepayment penalty, you won’t save on the loan, but you will get out of debt faster.”
Keep your eyes on the prize. If you want to pay off the loan in full, also ask your lender for the payoff amount.
“The payoff amount is your total loan balance plus any accumulated interest on a specific date,” Serio says. “ Ask for the payoff amount for the date when you plan on making the repayment so you know how much you need to pay in total.”
Decide what payment method you want to use. “Some common repayment strategies include making repayments every two weeks, rather than once every month, which reduces the interest cost and slightly increases the frequency of repayments,” Serio says. “Others plan on putting any additional windfalls like bonuses toward loans when they can or simply pay a little more than they have to each month.”
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Brian O'Connell has been a finance writer at TheStreet, TheBalance, LendingTree, CBS, CNBC, WSJ, US News and others, where he shares his expertise in personal finance, credit and debt. A published author and former trader, his byline has appeared in dozens of top-tier national publications.