Should You Pay Off a Loan Early?

Paying off debt early feels good, and often it’s the smartest thing you can do with spare cash. But not always. The decision comes down to one comparison — the loan’s interest rate versus what the money could earn elsewhere — plus a few practical checks. Here’s how to make it.

The core comparison

Paying $1,000 extra toward a loan at 9% saves you 9% a year in interest on that $1,000, guaranteed, with zero risk. That’s equivalent to earning a 9% risk-free return, which is better than anything a savings account offers and comparable to what stocks average over long periods — but without the risk.

So the rule of thumb:

Loan rate	Extra payments are…
Above ~7% (credit cards, most personal loans, many auto loans)	Almost always the best use of spare money
4–7% (many mortgages, student loans)	A judgement call — reasonable either way
Below ~4% (older mortgages, some auto promos)	Usually better to invest instead, keep the cheap debt

Tax treatment can shift these bands. US mortgage interest is deductible only if you itemise, which most people don’t since 2018, so for most households the mortgage rate is the real rate.

Do these first

Before making extra payments on anything:

1. Build a small emergency fund — at least one month of expenses, ideally three. Money paid to a lender is gone; you can’t get it back in a crisis without borrowing again, usually at a worse rate.
2. Capture any employer retirement match. A 50% or 100% match is an instant return no loan payoff can beat.
3. Kill the highest-rate debt first. Extra money on a 4% mortgage while carrying a 24% card balance is the wrong order.

How much do extra payments actually save?

Small amounts, applied early, have outsized effects because interest is charged on the outstanding balance (here’s why). Some examples from the calculators:

• Personal loan, $15,000 at 9.5% over 36 months: an extra $100 a month clears it in 30 months instead of 36 and saves about $450.
• Auto loan, $33,000 at 7.5% over 60 months: an extra $150 a month finishes it a year early and saves around $1,500.
• Mortgage, $320,000 at 6.5% over 30 years: an extra $200 a month pays it off six and a half years early and saves roughly $105,000.

Enter your own loan in the loan calculator or mortgage calculator with an extra payment to see the exact figure.

The case for investing instead

If your loan rate is low and you have decades ahead of you, the maths favours investing. $200 a month for 23½ years at a 7% return grows to about $149,000; the same $200 on the mortgage above saves about $105,000 in interest. The investment wins on paper, but it isn’t risk-free, it isn’t guaranteed, and it requires the discipline to actually invest the money rather than spend it.

Many people split the difference — some extra toward the loan, some into investments — and that’s a perfectly rational answer. The compound interest calculator lets you compare the two paths side by side.

Practical checks before you pay extra

• Prepayment penalties. Rare on mortgages now, but still present on some auto and personal loans. Read the agreement.
• How the lender applies extra money. Some apply it to next month’s payment (which saves nothing) unless you specify “apply to principal.” Write it on the cheque or select it online, then check the next statement.
• Precomputed-interest loans. Some subprime auto and furniture loans calculate all the interest up front (the “Rule of 78s”). Paying early on those saves much less than you’d expect; ask the lender for the payoff amount.
• Liquidity. Once paid in, the money is locked in the asset. For a mortgage, you’d need to sell or refinance to get it back.

Three ways to pay extra

1. Round up. Pay $500 instead of $480. Painless, and it adds up.
2. One extra payment a year. Split your monthly payment in half and pay every two weeks — you’ll make 26 half-payments, i.e. 13 full ones. On a 30-year mortgage this alone cuts nearly six years.
3. Windfalls. Tax refunds, bonuses, gifts. Lump sums early in the loan have the biggest effect.

The short version

High-rate debt: pay it off, fast, after a minimal emergency fund. Low-rate debt: keep it, invest the difference, and let compounding work for you. Mid-rate debt: either answer is fine — pick the one you’ll actually stick to, because consistency matters more than optimisation.