Making a small extra monthly payment will lower your total interest. When you make extra payments for loan principal it will reduce the total amount that you repay total interest. Making extra payments will reduce the loan terms and this will help you in clearing the debt fast. The future monthly payments can be reduced by making extra payments.
To understand whether extra payments can affect your personal loan payments let’s dive into the advantages and disadvantages of making extra payments on your loan.
Advantages of extra payments on loan
Saving the Total interest is one of the biggest advantages of making extra payments on personal loans. Extra payments can reduce the principal, the interest charged is also lower.
The number of installments will reduce overall when you make extra payments on your debt. Borrowers who want to come out of debt faster can pay extra payments and reduce the number of installments.
Once the loan is paid off you can put the installment money into savings or meet other financial goals.
By using a personal loan calculator you can find out the savings and then compare them with multiple extra payments.
Disadvantages of extra payments on loan
When you are making extra payments on loan then you are adjusting the money flow towards extra payments.
When you are making extra payments you need to check if the lender charges extra on early payments. There is a concept of prepayment penalty where the lender charges certain amounts or a certain percentage on the principal amount for extra payment.
The Prepayment penalty may be a burden because you are already paying interest and again paying a penalty on top of this is not worth it. Check with your lender if there is a prepayment penalty. If there is a prepayment penalty then how much it is and what are the charges.
You can use the loan calculator and find out the amount you can save on interest when you make extra payments. You may sometimes find it worth it to pay the prepayment penalty and close the loan as soon as possible as you will avoid high interest charges.
If you pay off the personal loan early it will affect your loan tenure history by decreasing the number of years of personal loan. The higher the loan tenure and regular payment the better it is for your credit score.
Every month the payments are reported to the credit bureaus and they will update your track record. A good track record of payments and a long loan payment history will help you get a good credit score. Paying off a debt faster is always beneficial then paying a loan for a longer period of time.
Things to consider when making extra payments
Making extra payments is not simple and easy unless you have a reserve amount of money on hand. If you are relying on a monthly salary and then trying to make extra payments then cash circulation will become difficult. If you have got a good bonus amount or good hike in salary then choosing to make extra payments is a wise decision.
You can also use the extra cash on hand to build an emergency fund and this will make sure that you are able to afford to meet any emergency expenses.
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How to Pay Off Personal Loans quickly?
Debt repayment can be more manageable if you take certain steps in repayments and certain other cash management techniques which are discussed below.
- Reduce unnecessary expenses
- Making Biweekly payments
- Refinancing
- Passive Income
1. Reduce unnecessary expenses
By reducing monthly expenses you will get extra income from your savings which will help you to pay extra payments on the loan. Review the monthly budget and cut down unnecessary expenses so that you can have a good amount on your hand. Simple daily practices like cooking at home, cutting down on luxuries, cutting down on entertainment and such other things will help you to save money from your salary.
2. Making Biweekly payments
Make Biweekly payments but get ready to bear the extra payments every month and this will help you to accelerate debt payoff. Adding additional payments to your Biweekly payment will reduce the number of installments remaining on your loan account.
Click here for How to Pay Off a Personal Loan Faster?
3. Refinancing
Refinancing your loan is another way, where you will get a new loan with lesser interest and there you can save interest and pay loan very faster. Prior to refinancing it is important that you repay the loan. Plan for repayment of the loan and get a new loan which will help you to reduce the financial burden. If you do not repay the loan and take additional loans you may fall in to the debt trap.
4. Passive Income
Having a passive income will generate additional income. Extra income will help you to make the extra payments on the loan. You can earn passive income by doing a part time job, investing in shares, starting side hustle, selling unused stock and many other ways. Earn extra income and make extra payments on loan to reduce the debt burden.
How does extra payment affect a loan?
When the borrower makes the extra payment on the loan it is applied to the principal balance. Once the principal balance reduces the loan amount will reduce this will help you in reduced payments. If there are reduced monthly payments then there is less financial burden every month. You can reduce the number of installments on the loan or you can reduce the interest amount on the loan. On a proportionate basis when you repay extra payments the number of installments are adjusted and reduced based on the extra payment you make.
Take away
Extra payments will reduce the total amount you owe and thereby reduce the number of installments. Before you make the extra payments check with the lender for a prepayment penalty. If you are satisfied with the calculation that you are not in a loss by paying prepayment penalty then go ahead and make extra payments on the loan. Paying extra payments will help you to close the debt faster and you can save a lot of money.
About the author
Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.
