Wise bread picks
Debt stink. We all know that. The wise move here is to pay off all debts as soon as possible, right? Not so fast. In some cases, paying off your debts early will not save you that much money. Before you need to do this, let’s take a look at the pros and cons of debt settlement.
Pros: You save thousands of dollars in interest
You cannot take out a loan without paying interest. Nor can you keep a credit card balance without paying interest. And the longer you owe money, the more interest you pay. Let’s say you buy a car for $ 25,000 and borrow $ 20,000 at 3 percent on a 60 month loan. That could mean more than $ 1,500 in interest payments over five years. What a waste, right?
Whether it’s a car loan or a credit card debt, the sooner you wipe it out, the more money you’ll save on interest payments. Depending on your account balance, this could mean hundreds or even thousands of dollars. (See Also: 15 Tips From People Who Have Paid Off An Incredible Amount of Debt)
Con: You may have already paid back most of the loan interest
Most loans have a so-called “amortization schedule” that tells you how much you are paying in interest and how much you are paying in principal each month. With many loans – especially mortgages – you pay most of the interest in the first few years and pay most of the principal later.
For example, let’s say you have a 30 year loan of $ 300,000 with an interest rate of 5 percent. With this handy payback calculator, you’ll pay $ 1,610 per month. (For simplicity, I don’t include taxes and insurance in this calculation.) A typical amortization schedule shows you start making interest payments of $ 1,250 per month. However, towards the end of the loan period, your interest payments will be much lower. If you have three years left, you’ll be paying just over $ 200 in interest a month, and from there the interest will keep falling.
If you are quite late in the loan term, there is not much financial benefit to repaying your loan early. You’re borrowing virtually interest-free at this point, so you might as well keep your money or use it for something else. (See Also: 5 Debt Management Questions You Are Too Embarrassed About)
Pros: You free up cash for other things
Your mortgage is $ 1,500 per month. Your auto payment is $ 200 per month. Your student loan payment is $ 180. The minimum payment on your credit card balance is $ 250. If you are tied to these payments every month, there may not be much money left for other needs or wants. Debt prevents you from having real financial flexibility. Pay off that debt early and breathe easier knowing you have released a significant amount of cash.
Con: You could run out of your emergency fund
Your drive to pay off debts early may be strong, but where does the money come from? For example, it is not easy for most people to repay the remaining $ 20,000 on a mortgage in one fell swoop. When you have that much cash to hand, you need to make sure it isn’t coming from your emergency fund. It may feel good to pay off a debt, but when you run out of money to cover a medical emergency or job loss, you are playing a dangerous game. It’s best to hold cash on living expenses for at least three months and avoid the temptation of robbing them just to pay off a debt early. (See Also: 7 Easy Ways To Build An Emergency Fund From $ 0)
Pros: You’ll sleep better
For many people it is physically and mentally demanding to go through month-to-month debt. It burdens you. And that is completely understandable. Everyone has their own level of comfort with debt, and if you just can’t stand the thought of low debt, pay off those loans in full when you can. In many cases, early repayment of a debt offers intellectual and financial freedom. (See also: How More Sleep Will Help Your Finances)
Con: You could stop building credit
Believe it or not, early debt repayment can actually damage your credit. If you insist on always paying off debts in full long before they become due, you may no longer have enough credit to get a cheap rating from the credit agencies. As long as your debt load is not too high, the best way to build strong credit is to make regular and regular payments on debts and pay bills on time.
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