Debt stinks. This is something we all agree on. It seems sensible to pay off all your debts as quickly as possible. But not so fast. Paying off a debt early can save you money in some cases. We’ll look at some of the pros and con of paying off debts before you need to.
Save thousands in interest
It is impossible to take out a credit card without paying interest. A credit card balance cannot be carried without interest. The longer you have to pay, the higher the interest rate. Say you purchase a car at $25,000 and borrow $20,000 with a 3 percent interest rate on a 60 month loan. This could result in more than $1500 of interest payments over a five-year period. Wasting money is a terrible idea, right?
If you have a credit card or car loan, the sooner it is paid off, the more you will save on interest. Depending on the amount, you could be saving hundreds or thousands of dollars.
Con: You might have already paid off the majority of your loan interest
The “amortization schedules” of most loans show how much interest you will pay and how much principal you will pay each month. Most loans, especially mortgages, have an amortization schedule that shows how much you’ll pay in interest and principal each month.
Let’s say, for example, that you have a loan of $300,000. It has a 5-percent interest rate. This means that you will pay $1,610 a month using this amortization tool. For simplicity, I have not included taxes or insurance in the calculation. An amortization schedule of a typical loan shows you paying $1,250 in interest at first. Towards the end of your loan period, you will see a much smaller interest payment. You will pay about $200 per month in interest by the end of the three-year loan. It will then continue to decrease.
Paying off your loan early is not beneficial if you’re late on the term. At this point you are borrowing money almost interest-free, so it is best to hold on to your cash and use it for other things.
Benefits: You can use the money for other purchases
Your monthly mortgage payment is $1,500. Your monthly car payment is 200 dollars. Your monthly student loan payment is $180. Your minimum credit card payment is $250. You may not have much money to spend on other wants or needs if you are locked into making these monthly payments. You can’t be flexible financially if you have debt. You can breathe easier knowing that you have freed up significant cash by paying off your debts early.
Con: You may deplete your emergency funds
You may have a strong desire to pay down debts early, but how will you do it? Most people can’t pay off $20,000 of a mortgage at once. You should not use your emergency fund if you have this much money. You may be tempted to pay off debts, but if you don’t have enough money to cover an emergency, such as a job loss or medical crisis, then you are playing a risky game. Avoid the temptation to withdraw money from your cash reserve to pay off debts early.
You will sleep better
Carrying debt from one month to the next is mentally and physically exhausting for many people. You feel the weight of it. It’s completely understandable. If you are uncomfortable with the idea of debt, you should pay off your loans in full. Paying off debts early can offer you financial and mental freedom.
Con: You might stop building credit
Paying off debts early can actually damage your credit. You may not have enough credit history if you always pay off debts before the due date. If your debt load isn’t too heavy, paying debts regularly and on time will help you build credit.
