Paying off debt seems like it should always be a good thing, but this is not always the case. Take a look at some pros and cons of paying off your debt early. Some of the cons might just surprise you.
Pros Of Paying Off Debt Early
Let’s start with the benefits of paying off your loan debt.
If you have a loan, you know that you are paying interest and potentially lots of it. Paying off your loan early can potentially save you hundreds or even thousands of dollars in interest.
Once you have this loan paid off, you can then start diverting your payment and the interest that you have been paying into a savings or investment account.
With that loan paid off, you will have lower monthly fixed bills. Having lower bills may allow you to splurge on enjoying life more. Perhaps it will allow you to travel more and just live a little better. It can also allow you to save more money which is a comforting thing.
Paying off your loan would lower your overall debt and that could improve your credit score. With an improved credit rating, you can save on all of your future financing and even some of your bills such as auto insurance.
Cons Of Paying Off Debt Early
Now for the cons of paying off a loan. Believe it or not, there are some.
Lower Credit Rating
Yes, paying off a loan can actually lower your credit. This is a situation that many student loan borrowers face all the time. They pay off their loan and find that it cost them 20 points on their credit score.
The reason for this is that it lowers your credit diversity. Lenders like to see a mix of credit types on your report and sometimes the loss of an installment loan can throw odd the mix.
Sometimes, your money might be better used elsewhere. Paying off debt and eliminating interest is important, but not if it costs you money overall.
Let’s say that you have a low interest home loan costing you 3.5 percent. Paying off this loan early would not be as beneficial as putting the extra money in an investment account earning 6 percent.
Weigh the benefits versus the cost before making a decision to payoff your loan. Paying off debt is not always the best way to use your money.
Sometimes there are early payment penalties. This is something that is more common in personal loans and business loans.An example might be a 3 percent fee on outstanding debt. So, if you pay off a loan with a remaining balance of 10,000 dollars, your penalty could be 300 dollars.
If your loan has a prepayment penalty, it is likely that the savings in interest would be negated, at least partially, by this penalty. Check your loan contract before proceeding if you are unsure.
Drop In Savings
The last thing that you would want to do is plunder your savings account in order to pay down debt. You need to have at least 6 months worth of expenses in savings to handle unforeseen issues. Sure, it would be nice to have that debt paid off but what would happen if you faced a sudden illness or loss of income. Pay down your debt after you have sufficient savings and do not use emergency savings to pay off debt.