If you have a personal loan, you may consider paying it off early. Whether you can do so in full or in part depends on the loan agreement you have with the lender. You’ll likely be charged fees too.

In this guide, we’ll detail the potential benefits of paying a loan off early, the fees you may need to pay and how to do it. We’ll also look at how it can affect your credit score.

Early repayment charges (ERCs)

Lenders should allow you to pay back your loan in full early, but they can charge you for doing so. This is called an early repayment charge (ERC). Sometimes a lender won’t charge you an ERC, but most do. It’s important to check your loan agreement, as this should detail all potential fees and charges.

In most cases, the amount you need to pay depends on how much you borrowed in the first place and how long you have left on the loan.

The amount lenders can charge is governed by the Consumer Credit Act. If your loan term is less than 12 months, lenders can charge up to 28 days’ interest. If it is longer than 12 months, lenders can charge up to 58 days' interest.

Lenders may also be able to charge further fees if you pay your loan back in full or make an overpayment.

If you pay less than £8,000 over the course of 12 months (either as a one-off payment or regular payments), you shouldn’t be charged a fee.

If you pay more than £8,000, the maximum you can be charged depends on the length of your loan agreement:

• With less than one year left on your loan, the lender can charge a maximum of 0.5% of the amount you repay early.
• With more than one year left on your loan, the lender can charge a maximum of 1% of the amount you repay early.

This applies to both full repayments and partial overpayments – where you pay back some of the loan early, but not all of it.

Why do companies charge early repayment charges?

When a lender offers you a loan, they calculate how long it will take you to pay it back and the interest they charge over this period. By paying it back early, you reduce the term and the amount of interest to be paid. This means the lender will lose out. They claim some of this back through early repayment charges.

Can I complain about an ERC?

Early repayment charges need to be “fair”. If you don’t think your ERC is fair and think you’re being charged too much you can refuse to pay it and continue with your loan agreement. Or you can complain about the charge. First, speak to your loan provider and then if you are still not satisfied, contact the Financial Ombudsman Service for free.

How do I pay off a loan early?

First, you’ll need to contact your lender and ask them for an early settlement amount. They will then give you a settlement statement, within seven days of receiving your request, covering:

• The amount you’ve already paid off
• What you still owe
• Early repayment charges or other fees that apply

You then have 28 days to decide whether you want to make the early repayment. If you do decide to pay your loan off early, simply make the payment in line with the early settlement amount. If you don’t pay it off early, just carry on with your monthly payments as normal. You can always ask for another early settlement amount in the future.

How to make an overpayment

The exact process depends on your lender. Get in touch with them to find out how to make an overpayment. With some, you’ll need to contact them directly and make the payment over the phone. Other lenders are happy for you to pay online or through mobile banking.

At this stage, it’s important to know how an overpayment affects your loan moving forward. In some cases when you make an overpayment, your monthly payments will stay the same and your loan term will reduce. This helps you pay the loan off quicker and save on interest. In other instances, the loan term may stay the same but the monthly payments will be less.

Cancelling a loan

You can cancel a loan right at the start of the agreement. If you took the loan out less than 14 days ago, you’re in the cooling-off period. During this time, you can cancel the loan in its entirety without being charged any extra costs. You need to contact the lender in these 14 days and let them know you want to cancel. They will then give you a specific period – usually 30 days – to pay back the loan in full.

Is it good to pay off a loan early?

So, should you keep your loan or pay it off? There are plenty of advantages of paying your loan off early, including:

• You’ll pay less in interest: If you pay some or all of your loan off early, you won’t have to pay the full amount of interest detailed in the original loan agreement. As ERCs are capped by the Consumer Credit Act, you will save money in the long run.
• You’ll be debt-free sooner: By clearing your loan early, you’ll save money each month that would have gone towards the debt. You can use this to clear other debts. If you’re debt-free, you may be able to start saving.

Before you pay back your loan early, remember there will likely be early repayment charges and other fees to pay. If you have other debts with higher interest rates, like credit cards, it often makes sense to clear these first before you pay back your loan.

Does early repayment affect my credit score?

Whilst you will save money by paying back a loan early it may  have a small impact on your credit score dependant on how many credit facilities you are currently paying off.

Making regular payments every month towards your loan is good for your credit score, as it shows responsible borrowing and that you can manage your finances. So, it makes sense that no longer making these payments can impact your score. As your loan term with the lender is now shorter, it means the history of making repayments on time will also be shorter.

Remember though, the impact is likely to be minor and much less than the credit score problems a missed payment can cause.

Consider debt consolidation

If you’re not able to repay your loan in full – and if you have other debts – consider a debt consolidation loan. If you can find a personal loan with a lower interest rate than your current loan, it could work out as a cheaper option.

Use our helpful personal loan calculator to see how much a new loan could cost you. Just consider that when refinancing to a new loan, there will likely be early repayment charges on your current loan to factor in.

*Please remember that by consolidating existing borrowing, you may be extending the term of the debt and increasing the total amount you repay.

How Asda can help

Not only do we work with a panel of trusted UK lenders to help you find the right personal loan for your needs. But we also offer free, impartial advice and support on all things money through our Financial Support.

Whether you need help understanding terms with our jargon buster or you want to check your financial health, we’re here to help.