To pay off a loan early, pay the entire outstanding balance along with the upcoming month's interest. This eliminates the debt, saving you a lot of money over the life of the loan. Yet though this sounds prudent, early payoffs don't always make financial sense. Long-term loans often charge low rates, and investments, such as bonds and retirement accounts, may offer higher returns. To determine whether to pay off your loan early, calculate the savings from the early payoff so you can compare them to your potential gains from investment.
1. Divide the annual interest rate on your balance by 12, which is the number of months in a year. For example, if you have taken out a $40,000 simple-interest loan that applies 3.5 percent annual interest, divide 0.035 by 12 to get 0.00292.
2. Multiply this monthly interest rate by your outstanding balance. For example, if you are 36 months into the loan and have a remaining balance of $15,500, multiply 0.00292 by $15,500 to get $45.26.
3. Add this amount to your outstanding balance. Continuing the example, add $45.26 to $15,500 to get $15,545.26. This is the size of your final payment for an early payoff.
4. Multiply the size of the monthly payments by the number of payments you made before the early payoff. Suppose you have paid $690 each month. Multiply $690 by 36 to get $24,840.
5. Add your final payment, which is $15,545.26 in this example, to get $40,385.26. This is the total amount you pay under early payoff.
6. Multiply each monthly payment by the number of months in the loan. With this example, multiply $690 by 60 to get $41,400. This is the total amount you would pay under the original schedule.
7. Subtract the amount you pay with early payoff from the amount you pay under the original schedule. With this example, subtract $40,385.26 from $41,400 to get $1,014.74. This is the amount you will save in interest through an early payoff.
- Pay off high-interest debt, such as credit cards, before paying off long-term loans early.
- Some loans charge a prepayment penalty for early payoffs, which reduces your savings.
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