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How to Pay Off a Loan Early
Paying off a loan early saves interest and frees up your monthly budget sooner. The trick is knowing which extra payments help most — and checking two things with your lender before you start.
Pay extra every month
The simplest way is to add a fixed extra amount to your normal payment. Interest each month is charged on the balance, so every extra dollar cuts the balance and shrinks the next month’s interest. Take a $20,000 loan at 7.5% (an example rate) with 60 months left: the normal payment is $400.76 and the total interest is $4,045.54. Pay $100 extra a month and the loan ends in 47 months instead of 60 — 13 months sooner — with $964.55 less interest. Pay $200 extra and it ends in 38 months, saving $1,551.63. Even $25 extra saves $294.83 and finishes the loan 4 months sooner. Work out your own numbers on the Loan Payoff Calculator.
Pay a lump sum when you can
A lump sum — a tax refund, a bonus, a sold item — helps most when it lands early in the loan, because it cuts the balance that every later month’s interest is charged on. The same $1,000 paid in year one saves more interest than the same $1,000 paid in year four. There is no magic amount: any lump sum that goes to principal saves interest.
Biweekly payments: the one-extra-payment trick
Paying half your monthly payment every two weeks adds up to 26 half-payments a year — 13 monthly payments instead of 12. That one extra monthly payment a year shortens the loan and saves interest, and it fits a biweekly pay schedule. It works because of the extra payment, not because of the timing: paying the same extra amount once a month does the same job.
Two things to check first
First, check for a prepayment penalty. A few loans charge a fee for paying early, and on those the fee can eat the saving. Second, make sure extra payments go to principal. Some lenders apply extra money to future payments instead, which does not cut the interest. Tell your lender in writing that extra payments are to reduce principal, and check the next statement to see that the balance fell by the extra amount.
Should you pay the loan off or save instead?
Paying off a loan early gives you a guaranteed return equal to the loan’s rate — 7.5% on the example above. A savings account usually pays less. But keep an emergency fund first: money paid into a loan is hard to get back in a hurry. A good order is: keep one month of expenses saved, then put extra money toward the highest-rate loan, then build the emergency fund up to three months of expenses.
What about refinancing?
Refinancing means taking a new loan at a lower rate to pay off the old one. It can save money if the new rate is clearly lower and the fees are small — but fees, a longer new term or a bigger balance can wipe out the saving. Compare the total interest on the old loan against the total interest plus fees on the new one, using the Loan Calculator for both, before you sign.
Sources and method. Standard loan amortization formula: monthly rate = annual rate / 12; monthly payment = P × r(1+r)n / ((1+r)n − 1). Simple interest I = P × r × t; compound interest A = P(1 + r/n)nt. Rates in the examples on this page are examples only, not live market rates. Results are estimates, not financial advice.
Estimate, not financial advice. This calculator uses the numbers you enter and the standard amortization formula. Your lender’s figures, fees and payoff rules can differ. Check the loan agreement and talk to a financial professional before you borrow.