Debt is one such a financial crisis every individual face at the point of life. Do you have debts that you consider to pay early? Everyone wants to be debt free. But did you know there are some pros and cons to paying off your debt early? Depending on your situation, paying it off early could improve 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 the terms of your loan, your money, and your goals.
1.Pro: You’ll save thousands of dollars in interest
You can’t take out a loan without paying interest. You also can’t carry a credit card balance without paying interest. And the longer you owe money, the more interest you’ll pay. Let’s say you buy a car for the price of $40,000, and you borrow $30,000 at an interest rate of 3 percent on a 60-month loan. That could mean more than $2,000 in interest payments over the course of five years. What a waste, right?
So whether it’s a car loan or credit card debt. The sooner you wipe it out, the more money you’ll save in interest payments. Depending on the balance, this could mean hundreds or even thousands of dollars.
2.Pro: You free up cash for other things
Your mortgage is $1,500 a month, car payment is $300 per month. The minimum payment on your credit card balance is $250. If you’re locked into these payments each month, you may not have a lot of money left over for other needs or wants. Debt prevents you from having true financial flexibility. Pay those debts off early, and breathe easier knowing you’ve freed up a significant amount of cash.
3.Pro: You’ll be free from mental stress
For many people, carrying debt from month to month is physically and mentally exhausting. Everyone has their own comfort level with debt. If you simply can’t stand the thought of even a small debt burden, pay those loans off in full if you can. In many cases, paying off a debt early offers mental and financial freedom.
1.Con: You could deplete your emergency fund
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. It’s best to keep at least three months worth of living expenses on hand in cash.
2.Con: You may have paid off most of the loan interest already
Most loans have something called an “amortization schedule” that maps out how much you’ll pay in interest and how much you’ll pay in principal each month. With many loans — especially mortgages — you pay most of the interest in the early years and pay mostly principal later on.
let’s say you have a 20-year loan of $300,000 with a 5 percent interest rate. Using amortization calculator, you’ll pay $1,610 per month. (To make it understandable I am not including taxes and insurance in this calculation.) A typical amortization schedule shows that you will pay $1,250 per month in interest payments at first. But toward the end of the lending period, your interest payments are much lower. By the time you have three years left on the loan, you’ll pay a little over $200 in interest per month and it will continue to decline from there.
If you are fairly late in the loan term, there’s not a major financial advantage to paying your loan off early. You’re practically borrowing money interest-free at this point, so you might as well hold onto your cash or use it for something else.
3.Con: You might stop building credit
Believe it or not, paying off debt early may actually affect your credit. If you insist on always clearing debts in full long before they are due, you may cease to have enough credit history to get a favorable rating from credit agencies. As long as your debt burden is not too high, making consistent, regular payments on debts and paying bills on time is the best way to build strong credit.
“A man in debt is so far a slave”- Ralph Waldo Emerson
Being debt free gives you mental peace, can foster your productivity and helps to achieve financial independence and early retirement.
Did you ever clear your debt early than the term? What are the pros and cons you consider clearing the debt?
If you need more tips on financial independence and early retirement or investing in real estate, call Raj now, at 720 5151051 for professional assistance.
Photo by Sharon McCutcheon, on Unsplash