Does Paying Off a Personal Loan Early Hurt Credit? | Capital One (2024)

November 16, 2023 |5 min read

    A personal loan is a type of installment loan where you borrow a sum of money and usually pay it back in equal amounts over a set period of time. It’s a closed-ended credit account—unlike a revolving credit account—meaning once the loan is paid in full, the account is closed.

    Personal loans typically come with a fixed interest rate and repayment term. But if you find yourself with extra cash before the repayment term is over, it could be tempting to pay off the loan early. Before you do, you might want to consider how paying off a personal loan early can affect your credit scores and overall financial situation.

    Key takeaways

    • In most cases, you can pay off a personal loan early. Your credit score might drop, but it will typically be minor and temporary.
    • Paying off an installment loan entirely can affect your credit score because of factors like your total debt, credit mix and payment history.
    • The benefits to paying off a personal loan include reducing your debt-to-income (DTI) ratio and saving on interest over the course of the loan.
    • Before deciding to pay off a personal loan early, it’s a good idea to check whether there’s a prepayment penalty.

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    Can you pay off a personal loan early?

    It could be possible to pay off your personal loan early—and the idea of saving money on interest doesn’t hurt.

    But first, it’s worth taking some time to make sure you won’t be charged a penalty for paying off your loan ahead of time. If that’s the case, you might want to consider whether your current surplus would be better spent on higher-interest debts or put toward your savings.

    There’s also your credit to consider.

    Does paying off a personal loan early hurt your credit scores?

    Yes, paying off a personal loan early could temporarily have a negative impact on your credit scores. But any dip in your credit scores will likely be temporary and minor. And it might be worth balancing that risk against the possible benefits of paying off your personal loan early.

    You might be wondering, “Isn’t paying off debt a good thing?” And generally, it is. But credit-scoring companies look at several factors when determining your scores. Things like your credit mix, payment history and total debt can be affected by paying off a personal loan.

    Benefits of paying off a personal loan early

    If paying off your personal loan early is part of your debt payoff strategy, here are a few potential advantages to consider:

    Reduce your debt-to-income ratio

    DTI ratio measures how much debt you have compared to your income. Lenders often use your DTI ratio to decide whether or not—and at what rate—you can manage monthly payments. And paying off a personal loan could improve your DTI ratio since it reduces your amount of debt.

    Save on interest

    When you borrow a personal loan, you agree to an annual percentage rate (APR), which is the price you pay to borrow money. Each loan payment you make will include an additional amount of interest on top. Typically, the rate varies based on your creditworthiness. The lower your credit scores, the higher your APR might be, which is more money out of your pocket.

    But say you pay off your loan one year early—that’s 12 payments, including interest, you won’t have to make. You might want to read the fine print of your loan terms for any prepayment fee and compare that to the interest you could save.

    Reasons why you might not pay off a personal loan early

    Paying down debt is generally a smart financial move. But there are certain situations when you might choose to continue making regular payments on a personal loan rather than pay it off early.

    If you have a low interest rate

    If you currently have a low interest rate on your personal loan, it could be worth first paying off other debts you may have. For example, if you have both a personal loan with a low interest rate and a credit card with a high interest rate, you may decide to put any extra money toward paying down the credit card debt.

    If paying down the loan would deplete an emergency fund

    Using cash to pay off a personal loan can reduce your overall monthly payment obligations. But you might reconsider if you’re using money from an emergency fund to pay down this debt. That’s because it’s a good idea to have cash readily available if an unexpected event were to occur.

    If your credit scores are going to be reviewed in the near future

    Paying off an installment loan entirely can result in a slight temporary dip in your credit scores. If you know your credit scores are going to be reviewed as part of an application for a mortgage or an auto loan, you might choose to postpone paying off a personal loan.

    If there’s a prepayment penalty

    Some lenders may charge a fee if you pay off your personal loan before the term ends. Called a prepayment penalty, it’s meant to protect the lender from losing revenue on interest.

    Before paying off a personal loan early, you might want to read the agreement or ask the lender about its prepayment terms. It could also be possible to pay off the loan early without a prepayment penalty if you pay it off within certain parameters. For example, a lender might allow you to pay up to a certain percentage of the total balance annually before charging a fee.

    Paying off a personal loan early in a nutshell

    Paying off a personal loan early can have advantages and disadvantages. Even though your credit score may take a slight hit, paying off a loan early can lower your DTI ratio and help you save on interest.

    Worried about your credit fluctuating when you pay off a personal loan early? Even if your score drops a few points, you could use other credit-building methods to repair or maintain a good credit score. Before paying off the loan, you can see how it might affect your credit score with the CreditWise Credit Score Simulator from Capital One. CreditWise from Capital One lets you monitor your credit health for free—without impacting your credit score.

    Whether you choose to pay off your personal loan early or put any extra cash toward something else is up to you. By understanding the pros and cons of an early payment, you can make informed decisions with your money.

    Does Paying Off a Personal Loan Early Hurt Credit? | Capital One (2024)

    FAQs

    Will my credit score go down if I pay off a personal loan early? ›

    Yes, paying off a personal loan early could temporarily have a negative impact on your credit scores. But any dip in your credit scores will likely be temporary and minor. And it might be worth balancing that risk against the possible benefits of paying off your personal loan early.

    Why did my credit score drop 40 points after paying off debt? ›

    It's possible that you could see your credit scores drop after fulfilling your payment obligations on a loan or credit card debt. Paying off debt might lower your credit scores if removing the debt affects certain factors like your credit mix, the length of your credit history or your credit utilization ratio.

    What happens if you pay your personal loan early? ›

    The benefits of prepaying a loan include: Interest savings: By eliminating future interest charges, you can significantly reduce the total interest paid. Enhanced credit score: Early repayment has the potential to positively influence your credit score.

    Is it bad to pay off a personal loan fast? ›

    Key takeaways. Paying off your loan early can save you hundreds — if not thousands — of dollars worth of interest over the life of the loan. Some lenders may charge a prepayment penalty of up to 2% of the loan's outstanding balance if you decide to pay off your loan ahead of schedule.

    Is it good to clear personal loan early? ›

    Your financial condition and your monthly expenses must be considered before deciding on closing a personal loan early. Foreclosing your loan can be done if you have the financial resources to pay it off early. It can save your interest payable, improve your credit score, and free up cash flow.

    How many points does a personal loan drop your credit score? ›

    How Much Can A Personal Loan Affect Your Credit?
    Loan EventHow Much Your Credit Score Is Affected
    Hard inquiryA drop of 1 – 5 points
    Missed paymentsA drop of up to 180 points
    Paying off the debtVaries based on payment history and standing with the personal loan and lender
    A delinquent accountA drop of 50 – 150 points
    Mar 29, 2024

    How can I raise my credit score 200 points in 30 days? ›

    Try paying debts and maintaining your credit utilisation ratio of 30% or below. There are two ways through which you can pay off your debts, which are as follows: Start paying off older accounts from lowest to highest outstanding balances. Start paying off based on the highest to lowest rate of interest.

    Why did my credit score drop 100 points after paying off debt? ›

    Why credit scores can drop after paying off a loan. Credit scores are calculated using a specific formula and indicate how likely you are to pay back a loan on time. But while paying off debt is a good thing, it may lower your credit score if it changes your credit mix, credit utilization or average account age.

    Why did my credit score drop 100 points after paying off credit card? ›

    Most credit score drops based on debt payoff alone are only temporary, and it shouldn't take more than a few months for your credit to rebound, according to Experian. In the meantime, the best thing you can do is monitor your credit report and ensure you pay all of your bills on time.

    Is it worth it to get a personal loan to pay off debt? ›

    As of November 2023, the average interest rate on a personal loan with a 24-month term was 12.35%, according to data from the Federal Reserve. So, by using a personal loan to pay off your credit card debt, there could be significant savings, as the average credit card rate is currently 21.47%.

    How to pay off a 5 year loan in 2 years? ›

    5 Ways To Pay Off A Loan Early
    1. Make bi-weekly payments. Instead of making monthly payments toward your loan, submit half-payments every two weeks. ...
    2. Round up your monthly payments. ...
    3. Make one extra payment each year. ...
    4. Refinance. ...
    5. Boost your income and put all extra money toward the loan.

    Does paying off a loan hurt credit? ›

    In general, paying off a loan won't have much of an impact one way or the other, and if your score does drop, the change will likely be temporary. But the presence of the account on your credit reports can continue to impact your scores for years to come.

    What is the fastest way to pay off a personal loan early? ›

    You can pay off a personal loan faster by putting a lump sum of extra money toward the principal, paying extra each month, or making biweekly payments instead of monthly payments, among other strategies.

    How long does it take for credit score to go up after paying off debt? ›

    Will paying off debt instantly improve my credit? No. But your credit score will go up once your debt status is reported to the credit bureau by the respective lender or bank. Wait for a month or 45 days to see the impact on your credit score when you pay off your debt.

    Why does credit score drop when a loan is paid off? ›

    You now have fewer types of credit accounts

    If you close an account that changes your credit mix, it could hurt your score. For example, if you only have credit cards and one personal loan and pay off your personal loan, you're down to a single type of credit.

    Do personal loans hurt credit score? ›

    A personal loan will cause a slight hit to your credit score in the short term, but making on-time payments will bring it back up and can help improve your credit in the long run. A personal loan calculator can be a big help when it comes to determining the loan repayment term that's right for you.

    How long will personal loan affect credit score? ›

    A personal loan can stay on your credit report anywhere from a few years to up to a decade, depending on how you managed your debt. Missed payments may remain on your report for seven years, while bankruptcies and closed accounts that you've paid in full could stay on your report for a decade.

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