Pay Off a Personal Loan Early or Pad Your Savings: What's the Better Choice?

As of the end of 2022, U.S. personal loan balances sat at $222 billion, according to TransUnion. That means they're clearly a popular borrowing choice.

One of the nice things about personal loans is that they allow you to borrow money for any purpose. You can take out one of these loans and use the proceeds to fix up your car, improve your home, or start a business if that's something you've always wanted to do.

Also, personal loans tend to offer competitive interest rates. Granted, the higher your credit score, the more affordable your interest rate is likely to be. But still, you may find that borrowing via a personal loan results in much lower interest changes than racking up a balance on a credit card.

But even though the interest rate on your personal loan might be reasonable, you should know that the sooner you pay your loan off, the less money you're apt to spend on interest. As such, if you come into extra money (say, due to a raise at work), you may be inclined to use it to pay off your personal loan ahead of schedule. But before you do that, ask yourself whether your savings could use a boost.

Make sure you're covered for emergencies

Your primary financial goal should be to have a fully loaded emergency fund -- one with enough money to cover at least three full months of living expenses at a minimum, and ideally more like six months' worth. If you don't have that amount of cash in your savings account, then you should take any extra money that comes your way and put it in the bank.

READ MORE: Emergency Fund Calculator

It's true that the interest rate on your personal loan may be higher than the interest rate your bank is paying you on your savings. But if you don't have a complete emergency fund, you might land in debt when an unplanned bill comes your way, or if you lose your job and it takes a while to find a new one. And at that point, your borrowing options may not be so affordable.

It's all about priorities

When you have a limited sum of money to work with in any context, it's important to set priorities. And so if you're torn between boosting your savings and paying off a personal loan balance early, you'll need to assess your emergency fund and see if it's complete. If not, your money should go there first.

But if you happen to have a nice, robust emergency fund -- one with enough money to cover half a year's worth of expenses -- then you can, and should, feel free to put extra cash you come across into your personal loan to get it repaid sooner. Personal loans generally do not charge a penalty for early payoff (though it's always best to read through your loan documents just to make sure). So if you're able to whittle yours down a little bit sooner, you stand to benefit financially.