Should You Repay Your Personal Loan Early?

Sometimes, life throws us a curveball, and we find ourselves in need of extra money. Thankfully, Singapore’s competitive banking industry, coupled with strict laws, allows for convenient and affordable personal loans.

Personal loans can help you get through a difficult time by providing the funds you need quickly. You can then repay the amount owed through regular monthly repayments. The longer your loan tenure is, the smaller your repayments will be. This allows you to find a loan that fits your financial situation.

Sticking to your original repayment plan is perfectly fine, but there may be certain situations when it might be advantageous for you to repay your loan early. These include the following scenarios:

If you are looking to purchase your own home and need a mortgage loan to do so, you should consider paying off your personal loan early. This can especially be helpful if your Total Debt Servicing Ratio (TDSR) is too high.

Your TDSR is a measure of how much income is going into debt repayment. Mortgage loans, if any, are also included in the calculation of your TDSR.

As you’re probably aware, there is a cap of 60% on the TDSR. Any mortgage loan that would push your TDSR above this limit will not be allowed.

This means that if your TDSR - without a mortgage loan - is say, 50%, any mortgage loans granted are likely to be too small to be useful. This will throw off your plans if you do not have enough cash savings to pay for your flat - a situation most of us will likely encounter.

Because personal loans count toward your TDSR, paying them off early will help you reduce your ratio. This will make room for a larger (and probably more useful) mortgage loan.

(For completeness, do note that if you plan to buy an HDB flat or an Executive Condominium, the maximum amount you can borrow is limited by the Monthly Servicing Ratio (MSR), defined as 30% of your gross monthly income. This is in addition to satisfying the TDSR.)

See also: Your go-to personal loans guide in Singapore.

There are many reasons to save money, including important ones like getting ready for retirement. Stepping aside from the ongoing debate on whether you should focus on saving money or clearing your debt, consider that the money you owe today will reduce the amount of money available for use tomorrow.

When saving for your retirement needs, the earlier you start, the better. Even 5 years can mean the difference between a comfortable retirement and one plagued by sleepless nights.

Funding a retirement plan while paying off your loans is like trying to fill up a tank using a leaky scoop. You’ll slog like crazy to make it happen but still end up thirsty in the end. Clearly, it is much better to be free of debt, so you can comfortably set aside money and easily increase your savings should the need arise.

However, this doesn’t mean you should wait till you pay up all your personal loans before starting to plan your retirement - it might be too late by then.

Hence, consider clearing your personal loans early so you can start saving for your retirement as soon as possible.

If you have a substantial amount of spare cash, like from your year-end bonus for example, you can simply make a lump-sum repayment and be done with it.

However, you don’t have to repay your personal loan all at one go, especially if that will only cause greater financial strain. You simply have to pay more than your monthly instalment each month.

For example, if you owe S$15,000 on a seven-year loan and repay an extra S$100 each month, simple mathematics tells us that you can pay back your loan in under five years. This will give your money an extra 24 months to grow, which will only put you in a better position for retirement.

One caveat, though; early repayment will incur a fee. This typically ranges from S$150 to S$250, or a certain percentage of your outstanding balance at the time of complete repayment - whichever is higher.

At the end of the day, when you think about the ability to free up your cash flow and start saving early, the early repayment fee is a small price to pay. Compare which is the best personal loan for your needs and preferences.

As previously mentioned, repaying a personal loan early can have its fair share of advantages. Some of them include:

Carrying debt, no matter how manageable, can often lead to financial stress and uncertainty. By repaying your personal loan early, you eliminate this obligation, giving you a sense of financial security. 

A debt-to-income ratio refers to the measurement of how much of your income is used to pay your debts. A high DTI ratio can hinder your ability to secure new loans or credit lines, such as a mortgage or car loan.

So when you pay off your personal loan early, you reduce your DTI ratio, which not only helps your financial standing but may also make you eligible for better interest rates and loan terms in the future.

Personal loans typically come with monthly repayments that take up a portion of your disposable income, so clearing your loan early allows you to free up this money. That way, you can redirect your disposable income toward other financial goals, investments, or expenses.

One of the biggest financial advantages of early repayment is the potential savings on interest. Personal loans accrue interest over time, and the longer the loan tenure, the more interest you pay overall.

So, paying it off ahead of schedule shortens the repayment period and reduces the total amount of interest charged.

While there are clear benefits to paying off a personal loan early, there are some downsides to it as well. Some of them include:

Your credit score is influenced by several factors, including your credit mix, payment history, and account age. As such, when you close a loan account early, this may slightly impact your credit mix, as having a variety of active credit types (e.g., credit cards, personal loans) is generally seen as favourable.

Additionally, an early payoff might shorten your account history, which can be another factor that affects your score. While the impact is typically minor, it’s something to consider if you’re planning to apply for a major loan soon.

Paying off a personal loan early is not always the best financial move if you have other high-interest debts. For instance, it’s more beneficial to pay off credit card balances, which often have higher interest rates, before clearing a low-interest personal loan. As such, failing to prioritise high-interest debts could mean you miss out on significant savings.

If you use a significant portion of your savings or emergency fund to repay a loan early, you risk leaving yourself financially vulnerable, especially during times of unexpected medical emergencies.

Many banks and lenders impose a prepayment penalty to offset the interest they lose when you repay a loan early. These penalties are often a percentage of the outstanding loan amount or a flat fee. Therefore, before proceeding with early repayment, review your loan agreement carefully to determine the cost of the penalty and compare it against the savings on interest.

Before you decide to pay off your personal loan early, consider these tips to ensure you’re making the best decision for your overall financial health:

Using all your available cash to pay off a loan early could leave you vulnerable if an unforeseen expense arises. Therefore, you need to make sure that you always have a solid emergency fund in place before paying off your personal loan early. It’s generally recommended to save enough to cover three to six months worth of living expenses, which covers medical emergencies, groceries, and more.

Always prioritise having liquid savings to protect yourself from financial stress.

It’s important to remember that some personal loan agreements include prepayment penalties, which lenders impose to compensate for the loss of interest income.

These penalties are typically a flat fee or a percentage of the remaining loan balance. For example, if you owe $10,000 and your prepayment penalty is 2%, you would need to pay $200 as a fee for paying off the loan early.

So before you decide to repay your loan ahead of schedule, carefully review your loan agreement or contact your lender to confirm whether a prepayment penalty applies.

If there is a penalty, calculate whether the interest savings from early repayment outweigh the cost of the penalty. If not, it might make more sense to stick to your regular repayment schedule.

To determine if early repayment is a financially sound choice, calculate how much you will save in interest by paying off your loan early. Personal loans accrue interest over time, so the sooner you repay the principal, the less interest you’ll pay overall.

For instance, if you’re on a five-year loan with a 10% annual interest rate, repaying it in three years instead of five could save you a significant amount in interest. Use an online loan payoff calculator or consult with your lender to get an accurate breakdown of potential savings.

However, remember to factor in any prepayment penalty and compare it against the savings to ensure early repayment is cost-effective.

Paying off your personal loan early might seem like a great way to reduce your debt burden, but it shouldn’t come at the expense of other essential financial commitments. Evaluate your current and future financial priorities to determine whether early repayment aligns with your goals.

Additionally, ensure that paying off your loan won’t deplete the funds you need for short-term expenses or significant life events, such as tuition, wedding expenses, or business investments.

Clearing a loan early typically involves a lump-sum payment or higher monthly instalments. Before committing, review your budget to ensure you are capable of adding extra payment without disrupting your day-to-day finances. Maintaining financial flexibility is crucial for managing unexpected expenses or pursuing new opportunities.

If you find that early repayment will strain your cash flow and potentially make you financially vulnerable, consider sticking to your original repayment plan. Then, gradually pay off the loan by making slightly larger monthly payments instead.

Read these next:
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Understanding personal loans: Why and when should you use it? 

Personal loan, credit line and balance transfer: The pros and cons rundown 

4 times in life you should consider getting a personal loan

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