Debt is a common financial burden that a lot of people face. Whether it's a student loan, a mortgage, a car loan, or credit card debt, paying off loans can take months, years, or even decades, and the interest charges can add up over time. So, with that in mind, is there anything you can do to speed up the process?
Well, if you have extra money lying around at the end of the month, would it make sense to put that towards some of your debt by making extra personal loan payments? The short answer is that in a lot of cases, this can be a smart move to help pay down your debt more quickly, but this won’t always be the case. In this article, we’ll explore the benefits of making extra loan payments, and provide practical tips on how to implement this strategy effectively.
What is an Extra Loan Payment?
An extra loan payment refers to a payment made on top of your required minimum payment towards a personal loan. It’s usually an additional payment made towards the principal balance of the loan, over and above the required minimum payment.
Extra loan payments can generally be made on various types of loans, like short-term installment loans, mortgages, student loans, and auto loans, and can be a proactive strategy to pay off debt more quickly and potentially improve one's financial situation.
Having said that, it’s important to point out that in some instances, making an extra personal loan payment may not always be the best idea. Why? Well, in order to ensure that they collect as much interest as possible, some financial institutions will force you to pay an early repayment fee if you decide to make any payments outside of your scheduled payments. This is generally meant to disincentivize you to make early payments. However, a lot of institutions will let you make payments outside of your typical schedule as much as you’d like. It’s important to find out whether or not you’re going to be penalized for making extra payments ahead of time.
Why Make Extra Loan Payments?
Assuming there’s no early repayment fee, making extra loan payments can have several significant benefits that may positively impact your financial situation. Here are some key reasons why you might want to consider making extra personal loan payments.
1. Save Money on Interest
Interest is the cost of borrowing money, and it can add up over the term of an installment loan, a line of credit, or any other type of loan. By making extra loan payments towards the principal, you can reduce the principal balance of your loan, which in turn reduces the amount of interest that accrues over time. This can result in interest savings, allowing you to save money in the long run.
2. Pay off Debt Faster
Making extra loan payments can help you accelerate your debt payoff timeline. By paying more than the minimum required payment, you can reduce the outstanding balance of your loan more quickly. As a result, you can pay off your loan faster and become debt free sooner, giving you greater financial freedom and peace of mind.
3. Lower your Credit Utilization Ratio
Your credit score is a crucial factor that many lenders consider when determining your creditworthiness. When it comes to revolving credit, it is important to be mindful of your overall credit utilization ratio, which is the amount of credit you’re using compared to your total credit limit. Making extra loan payments can reduce your overall credit utilization ratio, and it may have some impact on your credit score.
4. Reduce Financial Stress
Debt can be a significant source of financial stress for many people. Making extra personal loan payments can help you reduce your debt burden and alleviate financial stress. As you see your loan balances decreasing faster, you may feel a sense of accomplishment and motivation to continue paying down your debt, leading to improved financial well-being.
5. Flexibility in Future Financial Decisions
Paying off your loans faster with extra payments can provide you with more flexibility in future financial decisions. Once your loans are paid off, you’ll likely have more disposable income that can be directed towards other financial goals, like saving for a down payment on a home, starting a business, or funding your children's education. In the end, being debt free can be a huge help to your future financial outlook.
7 Tips for Making Extra Personal Loan Payments
Now that we’ve gone over some of the potential benefits of making extra loan payments, let's explore some practical tips on how to implement this strategy effectively.
1. Review your Budget
Before you start making extra loan payments, it's essential to review your budget and determine how much extra money you can allocate towards loan payments. Look for areas in your budget where you can cut back on expenses, like dining out, entertainment, or subscription services, and redirect those funds towards extra loan payments. Creating a realistic budget will help you identify how much you can afford to pay extra towards your loans without sacrificing your basic needs or other financial goals.
2. Prioritize your Loans
If you have multiple loans, such as a student loan and a car loan, it's important to figure out how you want to go about paying off your debt. There are two common approaches to prioritize loans: the debt avalanche method and the debt snowball method. In the debt avalanche method, you prioritize paying off the loan with the highest interest rate first, as it’ll save you the most money on interest charges in the long run. In the debt snowball method, you prioritize paying off the loan with the smallest balance first, which can provide you with a psychological boost and motivation to keep paying off debt. Choose the method that aligns with your financial goals and personal preferences.
3. Contact your Lender
Before making extra loan payments, it's important to contact your lender and ensure that your additional payments will be applied towards the principal balance of the loan. Some lenders may apply extra payments towards future interest or fees, which may not have the desired impact of reducing your loan balance and saving on interest charges. Clearly communicate with your lender that you want the extra payments to be applied towards the principal balance to ensure that you are maximizing the benefits of making extra loan payments.
4. Set up Automatic Payments
To ensure that you consistently make extra loan payments, consider setting up automatic payments. You can automate the process by scheduling extra payments to be made monthly or bi-weekly, depending on your financial situation and pay schedule. Automating your extra loan payments can help you stay disciplined and consistent with your debt payoff strategy, as the payments will be made automatically without requiring you to remember to make them manually each month.
5. Use Windfalls and Bonuses
Another effective way to make extra loan payments is to use any windfalls or bonuses you receive. This could include tax refunds, work bonuses, or unexpected cash inflows. Instead of using these windfalls for discretionary spending, consider putting them towards your loans as extra payments. By using unexpected or extra funds to pay down your debt, you can make significant progress in reducing your loan balances and accelerating your debt payoff timeline.
6. Consider Bi-Weekly Payments
If you have the option of determining the nature of your loan payment schedule, you may want to consider making bi-weekly payments. Making bi-weekly payments instead of monthly payments can also help you make extra loan payments without feeling the impact of larger lump sum payments. By dividing your monthly loan payment in half and making payments every two weeks, you end up making one extra loan payment each year. This is because there are 52 weeks in a year, and when you make bi-weekly payments, you end up making 26 half-payments, which is equivalent to 13 full payments. This extra payment can help you reduce your loan balance faster and save on interest charges.
7. Be Consistent and Stay Motivated
Making extra loan payments requires consistency and discipline. It's important to stay motivated and committed to your debt payoff goals, even when progress may seem slow at times. Remember the long-term benefits of making extra loan payments, such as saving money on interest charges, paying off your debt faster, and improving your credit score. Celebrate small milestones along the way to keep yourself motivated and focused on your financial goals.
Consider you Options Carefully
In the end, making extra loan payments can be a powerful strategy to accelerate your debt payoff, save money on interest, and improve your overall financial well-being. By reviewing your budget, prioritizing your loans, contacting your lender, setting up automatic payments, using windfalls, considering bi-weekly payments, looking for opportunities to refinance, and staying consistent and motivated, you can make significant progress in paying off your loans faster and achieving financial freedom. Just make sure that you find out whether or not you’ll be penalized for making extra payments ahead of time.
