The Pros and Cons of Paying off Debt Early
Do you have debts that you are considering paying your debt off early? Everyone wants to be debt free (well most of us do), but did you know there are some cons to paying off your debt early? Depending on your situation, paying it off early could damper your financial situation, so make sure you understand these cons before laying down that last payment.Here are a few pros and cons to weigh out before doing so. Some may not apply, but also make sure you take a good look at your loans, your money, and your goals.
Pro: Save on Interest
Any debt you take on has interest fees. With rates at 7% and higher, you could be paying longer for your purchase than you would have saved for it in the first place. You won’t put money in your bank account directly by putting all your money towards paying off this debt. However, you are generating a higher rate of return by eliminating all the interest you are by paying this debt off.
Pro: Get Back That Monthly Payment
Once you’ve eliminated this debt, you no longer have to make that month-to-month payment. This frees up your cash flow! So instead of paying $35.05 each month for the next three years, you now have $420.60 at the end of each year. Use this to pay off other debt, save in your emergency account, or save towards a purchase to eliminate using credit again.
Pro: Lower Your Debt-to-Credit Ratio
Your credit score is comprised of five categories:
- Payment history
- Amounts owed
- Length of credit history
- New credit
- Types of credit used
Lenders want to see not only a low debt-to-income ratio, but a low debt-to-credit ratio as well. It shows you are a responsible borrower, not maxing out your loans. Also, it shows you are going to pay it back and on time. So the higher your debt-to-credit ratio is, the more of a risk you are to lenders. This impacts you greatly when applying for a home or auto loan.
Con: Potential to Not Have the Savings You Need
If you pay your loan off early, chances are you’re applying all your excess funds to this venture. This means you are unable to save for emergencies or retirement goals. Once you’ve paid the debt off, you can’t get it back the next week in case an emergency arises. So before paying off a debt in full, try to anticipate your next move in case an emergency situation comes around. If you don’t think you have enough money to save, then try out the new service from Digit.
Con: Do You Have to Shell Out Cash?
Make sure to read the fine print before paying off a debt. There are prepayment penalties to consider. Lenders will charge this since they’d lose out on the interest you would have been paying. Not all lenders or scenarios have the prepayment penalty, but make sure you understand your loan before sending in the final payment.
Consider the above pros and cons before paying your debt off early. In the end, however, it’s best to have that freed up cash.
You’ll want to pay your debt off more quickly if the interest rate is high. My student loan interest rate is at 6.125%. I could try to beat that in the market or take the sure thing and pay it off quicker. I still set aside some for investments, but I don’t mind paying it off ahead of schedule for ease of mind and the sure-thing long term savings.