Carrying loan debt can be stressful if you have other things you’d rather be doing with your money — and, frankly, who doesn’t? This leads to the noble ambition of wanting to pay off your loans as early as possible, which can pay dividends for you in terms of saving money and anxiety. However, even if you have the means, is it always the right decision to pay off a loan or debt early? The answer may surprise you.
The upsides of paying off loans early
If you’ve come into some money and can use it to pay off an outstanding lingering debt, the benefits of doing so are clear. Paying off a loan that carries interest will save you the money that you would have spent on interest over the remaining life of that loan, taking money out of the hands of your lender and putting it back into your pocket. That money can be better used any number of ways, including saving, investing or even helping to pay off other loans.
Steve Nicastro of The Fiscal Times puts it in practical terms: Paying off a loan early is tantamount to an investment. If you pay off student loans that carry an interest rate of 7 percent, it’s like getting a 7 percent annual rate of return on that amount for the years you would have otherwise been paying it down, which can add up to thousands of dollars.
Nicastro also notes that paying off a loan early lowers your debt-to-income ratio, which increases the likelihood of being approved for a mortgage or auto loan. If you’ve gotten yourself into the habit of paying a certain amount toward a loan every month, you can stay in the habit and pay yourself instead, whether it’s by investing that money or putting it into your savings accounts. This approach should have you feeling more confident about your financial outlook.
Is there a bad time to pay off early?
Paying off a loan early seems like a win-win proposition, but there are times where it might actually be beneficial to keep your debt intact. One such instance, pointed out by Geoff Williams in U.S. News & World Report, is when you don’t have an extensive credit history. Building up good credit by making monthly payments on time and whittling down your debt gradually establishes you as less of a risk to lenders, who would use your positive credit history to determine how much to let you borrow on a mortgage.
Also, consider the simple fact that once you pay off your debt with a lump sum of cash, that money is no longer yours. While you’ll be free from the burden of making payments on a loan, you won’t have that extra money available if you should need it suddenly for a medical emergency or in the event of a job loss. If you want to pay off your loan, make sure you have a nice nest egg set aside first.
Once gone, that extra money also can’t be put to work for you. Justin Pritchard of The Balance notes that the money used to pay off a loan in one fell swoop could instead be used to earn a degree, make vital home improvements or even invest. These options can pay big dividends down the line, which might offset or supersede any money you’d save on your loan’s interest payments.
The answer to whether you should pay off a loan early or not largely depends on your financial situation and your level of comfort with pulling the trigger. Any and all major financial decisions should be mulled over with the utmost consideration — speak with your family about the pros and cons of your decision, and if possible, seek out the advice of a financial professional.