Paying off your debt can be a great feeling, and that includes paying it off early. But there are actually both pros and cons to doing so. Before you make the move to eliminate debt before you're scheduled to pay it off, consider the following.
PROS
Stress Relief
Having your debt paid off can alleviate the stress that comes with knowing that you owe money. The more debt you have, the more stressful your financial situation can be, so any time you eliminate debt, the closer you can be to financial peace.
Free Up Cash
If you eliminate debt, you will eliminate monthly payments, which means you'll have more cash on hand each month that can be put toward other causes, such as savings or purchases. Clearing a sizable debt out of the way may enable you to improve your quality of life by giving you some extra financial freedom.
Save on Interest
When your debt is paid, you will no longer have to worry about paying interest, which means you won't be putting money toward something you're not directly benefiting from.
"You can't take out a loan without paying interest," says Tim Lemke at Wisebread.1 "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 $25,000, and you borrow $20,000 at an interest rate of 3 percent on a 60-month loan. That could mean more than $1,500 in interest payments over the course of five years. 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, and depending on the balance, this could mean hundreds or even thousands of dollars."
You'll Be Able to Better Secure Your Future
You'll be in a better place financially by having less debt, so getting it paid off as soon as possible can help you secure your finances for the future. You'll be able to put money you would have spent on a payment into an emergency fund, a retirement account, or however you see fit.
CONS
Less Money in the Short Term
If you send extra money to your lender each month to pay down your debt, you may develop a cash flow problem in the short term because money that would otherwise have been available to you will now be going to your lender. That may require you to readjust your budget and reduce some of your other spending. Although it may open up further financial freedom over the longer term, your cash flow might just suffer for a while.
It May Be Too Late to Save on Interest
While you can save on interest by getting rid of your debt, there's also a chance that it's already too late to make much of an impact in this area. For example, some loans, such as mortgages, have you pay most interest early on, with payments counting more toward principal as time goes on. In such cases, if you're far enough into repayment, the money saved on interest won't actually make that much of a difference.
It May Negatively Affect Your Credit
It's common thinking that paying off any debt can only be good for your credit, but paying off some debts early might actually have the reverse effect.
As Credit.com explains, "Unfortunately, paying off non-credit card debt early might make you less credit-worthy according to scoring models. When it comes to credit scores, there’s a big difference between revolving accounts (such as credit cards) and installment loan accounts (such as a mortgage or student loan). Paying an installment loan off early won’t improve your credit score. It won’t necessarily lower your score, either. But keeping an installment loan open for the life of the loan could help maintain your credit score."2
There Might Be a Penalty
Some loans have a penalty for paying them off early. This is typically the case with mortgages, but can also happen with some other loans, though this should be spelled out in your loan terms. The reason these penalties exist is because paying off a loan early means the lender doesn't get to collect as much interest. The penalty is their way of making up for that.
In most cases, the pros of paying your debt off early will likely outweigh the cons, but it does depend on the terms of your loan and your particular situation. Be sure to review your loan agreement and consider all the above factors before making a decision.
1. https://www.wisebread.com/the-pros-and-cons-of-paying-off-your-debt-early
2. https://www.credit.com/blog/how-does-paying-off-a-loan-affect-your-credit-score-64668/
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice. Any views expressed in this article may not necessarily be those of Nevada State Bank. Nevada State Bank is a division of Zions Bancorporation, N.A. Member FDIC