How much sooner could extra repayments make you debt free?

Key points

• An extra repayment brings the payoff date forward and cuts the total interest at the same time, and on an expensive balance both effects are bigger than they feel.
• On a $5,000 credit card balance at 20.99% (illustrative) paying $150 a month, lifting that to $200 clears it 17 months sooner for ~$935 less interest, and $300 a month clears it 31 months sooner for ~$1,605 less.
• A $1,000 lump sum applied to that same balance at the start clears it about 14 months sooner for ~$1,133 less interest. The same $1,000 paid a year in saves ~$771, because interest keeps accruing until it lands.
• Credit cards generally accept extra repayments freely, however personal loans vary and fixed-rate loans may charge a fee if you repay early, so the contract is worth checking before you send a large payment.
• Sending everything at the debt and keeping nothing back often puts the balance straight back, because the next repair lands on credit.

If you've settled on a repayment you can hold every month and you've found a bit more to put at the debt, the question is what that extra money actually buys you. An extra repayment does two things at once. It brings forward the date the debt ends, and it reduces the total interest you pay getting there, because interest is charged on what's left and there's less left every month.

How big those two effects are depends almost entirely on the rate. On an expensive credit card balance the numbers can be larger than people expect, and on a cheaper loan they can be a lot smaller, which is worth knowing before you decide that's where the money is best spent. So here we go through what a regular extra repayment does, what a lump sum does, how much of one is worth sending, and what to check before you send it.

What a regular extra repayment does

Take a $5,000 credit card balance at 20.99% (an ordinary rate for Australian credit cards) with a fixed $150 a month going to it. That $150 is the base below, and anything above it is the extra repayment. Settling on a base repayment you can hold every month, and the order to do things in, we've covered separately.

The figures are illustrative, and they assume no new spending on the credit card, the rate staying at 20.99% and no fees, with interest worked out monthly at the annual rate divided by 12. If new spending is still going onto the credit card, the extra repayment is competing with it, and what's refilling the balance is the more useful thing to work out first.

The first extra $50 a month makes the biggest difference. That's ~$12 a week, and it finishes the debt 17 months sooner. After that each extra $50 buys less than the $50 before it, because there's less interest left to avoid: going from $200 to $250 saves another ~$425, and $250 to $300 another ~$244. Paying more still helps, however the later increases are worth weighing against whatever else that money needs to cover.

None of the rows above are the minimum repayment. The minimum on a credit card is set by the issuer, commonly the greatest of $25, 2% of your closing balance rounded down, and any amount by which the balance sits above your credit limit – your statement shows yours. Because it's a percentage of what you owe, it falls as the balance falls. What that does to a timeline we've gone through separately.

A personal loan behaves differently, because the term is set at the start. The scheduled repayment is worked out to clear the loan by the end of that term, so an extra repayment usually shortens the term rather than reducing the amount you're asked for each month. The saving works the same way (less interest and an earlier end date), it just shows up as the loan finishing early rather than as a smaller amount leaving your account. Whether extra repayments are allowed at all, and whether they cost anything, is set out in your loan contract. And where the rate itself is the problem rather than the repayment, refinancing the loan is a different question with its own place.

Pro tip: Once your accounts are connected in WeMoney the balance sits beside the repayments going out, so month to month you can check that the higher repayment is actually pulling the balance down faster.

What a one-off lump sum does

A tax refund, a work bonus, a payout from a job that ended – money that arrives once and isn't part of your normal pay is usually where the biggest single change to a payoff date comes from, because the whole amount comes off the balance at once rather than arriving $50 at a time.

Same $5,000 balance at 20.99%, same $150 a month, same assumptions. Put $1,000 straight onto it at the start and the balance clears in about 37 months (3 years and 1 month), with the interest coming to ~$1,434. Leave the $1,000 out and it clears in about 51 months (4 years and 3 months), with the interest coming to ~$2,568. So that one payment is worth about 14 months and ~$1,133 in interest, which is slightly more than the lump sum itself.

A lump sum applied early does more than the same amount applied later, because interest stops accruing on it sooner.

The same $1,000 paid a year into that plan saves ~$771 rather than ~$1,133, and nothing clever is going on there. Interest on a credit card is worked out daily (at 20.99%, that's 0.0575% a day on what you owe), and the day-to-day mechanics have their own explainer. Every day the money sits somewhere else is another day of interest on an amount you could have cleared, so if it's in an account earning less than the debt is costing you, sooner is cheaper than later.

Should the whole lump sum go at the debt?

Not usually, if it would leave you with no buffer (where a buffer already exists and the debt is expensive, more of the lump sum can reasonably go at the debt). The table above assumes the money has no other job to do, which for most households isn't the case.

A lump sum that clears a balance and leaves nothing behind puts you one repair away from where you started – the car needs brakes, there's no cash for it, and the cost goes back onto the credit card you just cleared. Our members have described that sequence to us often, and the reopening was the expensive part, because a credit card limit back in use rarely stops at the repair.

The split is worth deciding before the money arrives. If you don't hold a buffer yet, some of the lump sum going into one is what protects the rest of the work, and building an emergency buffer while paying off debt covers what holding that cash costs you while you're still carrying the debt, which is smaller than it feels. If you already hold a buffer that covers the shocks your household actually gets, more of the lump sum can go at the balance without leaving you exposed, and what changes once the buffer reaches four figures has its own place.

There's no single formula here, because the right split depends on what your household's shocks tend to cost and how expensive the debt is. What holds either way is the order each payday: minimum repayments on everything first, then the buffer, then any sinking funds for bills you already know are coming, and extra repayments on the priority debt last. Which debt counts as the priority is its own question, and we compare the two common ways of choosing separately. If a shock spends the buffer, pause the extra repayments, refill it, then resume. Pausing extra repayments while you refill the buffer is part of the plan.

Early-repayment restrictions worth checking

Credit cards generally accept extra repayments and one-off payments freely, and there's usually nothing to check before you make one. Personal loans vary more. Variable-rate loans often let you make extra repayments or pay the loan out early, while fixed-rate loans may charge a fee if you repay early. Where a fee applies it may appear as an early repayment fee or a discharge fee, and some contracts also cap how much extra you can pay in a year.

So if you're planning a large extra repayment or an early payout on a loan, check the contract or ask the lender what applies before you send the money. Lenders field that question every day and can tell you the exact figure for your loan. A fee doesn't necessarily make the extra repayment a bad idea either, it's an amount to take off the interest you'd save, and against a saving like the ~$1,133 above a modest fee still leaves you well ahead.

And where extra repayments are going out every month while several costly commitments are still running, each taking their share of the same payday, adding more to any one of them may not be what fixes it. Whether reorganising those debts into a single repayment would leave you better off is a separate assessment, and what it could cost or save has its own place to be worked through properly.

An extra repayment is easiest to keep up when you can see it doing something. Once your accounts are connected in WeMoney the debt sits in one place beside the buffer, so each month you can watch the balance come down against the plan you set.

Sources

• Moneysmart: Credit card calculator
• Moneysmart: Personal loans

This article provides general information only. It does not take your personal circumstances into account and is not financial, credit or legal advice. Consider your own situation and seek advice from a suitably qualified professional if you need it.