Should You Take a Shorter Repayment Term with a Personal Loan?
Personal loans are the fastest growing consumer lending option in the U.S., growing by a rate of 19.2% in the first quarter of 2019, on a year-to-year basis .
Americans apparently approve of their personal loan experience, which is largely handled online these days, with a wide variety of personal loan options.
Even so, like any big consumer financial move, personal loans need to be handled carefully – especially when it comes to repaying the loan. Case in point – the choices borrowers make in repaying personal loans.
The fact is, there are both upsides and downsides is shortening the length of a personal loan repayment timetable.
Factors like the amount of loan repayments, interest rates paid, and the size of the loan, among other factors, will impact any repayment decisions?
“Lenders generally base your loan term on your loan amount, rate and your monthly budget,” said Anna Serio, loan expert at Finder.com. “That’s why it can be helpful to have an idea of how much you need to borrow and how much you can afford to pay each month before you shop around for a loan. Use your loan amount and monthly repayment as a benchmark to find a lender that offers rates and terms that you can afford.”
What’s your best move in repaying a personal loan? Money experts advise a “Goldilocks” approach, where the best strategy meets your unique needs.
Paying Down a Loan Early: Pros and Cons
Paying down a personal loan early as possible does have its advantages.
“Paying off a loan as soon as you can gives you a lower total cost and gets you out of debt quicker,” Serio said. “Interest adds up over time, so the quicker you repay, the lower your loan cost. And getting out of debt frees you up for other types of credit and can increase your credit score.”
On the downside, during that repayment period, the borrower may have to dig deep to cover the loan.
“You’ll feel the cost of the loan a lot more when you repay it quickly,” Serio said. “That’s because short terms increase your monthly cost. And if your income takes an unexpected hit, this can make it harder to manage the cost. In some cases, it might even increase your chances of defaulting.”
Pros and Cons of Waiting to Pay It Off Early
Equally, there are pros and cons in delaying a personal loan repayment, as well.
“Signing up for a long term means you’ll have lower monthly repayments,” said Serio. “This means you won’t feel the impact of the loan as much each month as if you went for the short term.”
That gives you more wiggle room, which may appeal to more cash liquidity-minded borrowers.
“If you’re hit with a sudden loss of income you still might be able to afford your loan repayment because it isn’t as much of a strain on your budget,” she added. “And since most lenders don’t have prepayment penalties on consumer loans, you can often make extra repayments toward the interest whenever your budget allows.”
The main drawback to a long loan term is that you’ll pay more in interest.
“If your interest rate is high enough, the extra interest cost you pay might actually mean you aren’t saving that much each month,” Serio said.
Getting the Details Right
When repaying a personal loan, it’s also a good idea to keep a sharp eye on the financial moves that can trigger extra costs that too often, go sight unseen.
“Paying off a consumer loan early could be a good thing, that would save you hundreds, if not thousands, in interest alone,” said Kimberly Porter, finance expert and CEO of Microcredit Summit, a personal finance publication. “Some of the main factors that go into the loan repayment are credit worthiness, ability to repay, and income.”
Additionally, borrowers need to ensure that there are no early repayment, or payoff, fees included in a personal loan contract. “While less common now than they once were, you would hate to be hit with a large fee for paying off your loan early,” Porter said.
Interest rates matter, as well – especially extra money you’re paying when doing so could have been avoided.
“The biggest disadvantage to waiting to pay off your loan is the amount of money you throw into interest every month, however, although with a very low interest rate, that scenario might not be so bad,” Porter added. “If you have a very low interest loan, and don’t have lots of extra money to pay things off, then keeping to the original terms of the loan and paying the minimum payment is fine.”
Your best move to make when shifting into a loan repayment scenario? Go into your loan application with a monthly budget in mind.
“This is a great way to make sure you get a term that is manageable, but not so long that you’ll rack up interest,” Serio said. “Put any extra money toward repayments – after checking that your lender doesn’t charge prepayment penalties.”
If the Unthinkable Happens
If you’ve taken out a personal loan and recently lost your job, all bets are off and you’ll need to address your loan repayment scenario immediately.
“Your first step should be to reach out to your creditors and make sure they know about your situation,” said Freya Kuka, a personal finance expert and founder of the personal finance blog Collecting Cents. “Many lenders may give you some leeway if you come to them immediately after you lost your job instead of them having to hound you to pay them. Working with them to reduce or pause payments for a certain period of time can give you the help you need to get back on track.
Most banks and even credit card companies are offering some form of relief to customers that are dealing with financial hardships during the pandemic.
Due to the coronavirus, more banks are offering programs across the board to all their customers. For example, banks like Bank of America, Capital One, Wells Fargo, and Chase are all asking customers to contact them directly for help.
“Contacting your banks and asking them directly what options are available to you is always the best option during a time when you’re laid low financially” Kuka said. “Most banks are taking the necessary steps to make lower interest rates and financial relief programs available to their cardholders.”
Perhaps the biggest mistake people make when it comes to paying off debt is having no plan at all.
“Just paying loans and debt off as haphazardly as possible doesn’t work,” Kuka said. “This habit will not only leave you stressed out but it may also cause you to lose money. Doing something as simple as creating a debt payoff plan could wind up saving you thousands if you do it correctly.”
Kuka also advises against taking out any more loans in desperation to pay off existing debt.
“This may seem like a good idea, but your best bet is to stay away from further debt. Instead, reach out to your bank or even family to help you pay things off,” Kuka said.
Know where you stand, credit-wise. Last but not least, always be aware of your credit score.
“Despite many people relying on credit scores or suffering from loan debt, many are not regularly checking their credit score,” said Michael Broughton, Co-Founder of Perch, a fintech mobile application that helps users build their credit score. “Just like failing to financially plan, when people neglect their credit score, they’re shocked when they don’t qualify for a new car, an apartment, a credit card or a loan.”
To avoid that scenario, financial consumers should make checking their credit score a normal part of their financial routine. “By doing so, you’re aware of any major changes to your score to make sure you know where you stand. Plus, if you see any credit accounts or items you don’t recognize, you can dispute them.”
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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.