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Paying off debt early: Advantages and disadvantages

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As of the first quarter of 2021, the amount of consumer debt in the United States totaled over $14 trillion. A lot of Americans face extreme financial hardships, regardless of their age, education and income level due to overwhelming debt. Whether you’re buried under student loans, credit card fees or a mortgage you can’t afford, debt can land you in serious financial trouble.

Being in debt can be a slippery slope, which is why you should be doing everything in your power to pay off what you owe as quickly as possible. Most banks allow you to pay off a loan early, but it won’t be easy. There’s usually a minimum monthly amount you have to pay toward that debt, and the minimum won’t get your debt cleared quickly. If you want to be financially stable, know how to pay off a debt early and when you should consider doing so.

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When does it make sense to pay off debt early?

Is it better to pay off a loan early, and can you pay off a loan early? The short answer is almost always yes. If you have the financial means to pay back a loan or credit card balance before it’s due, it’s usually a smart financial move to do so.

“Living with debt is a heavy burden. The financial obligation can limit your ability to say yes to new opportunities and leave you feeling stressed and depressed,” says Leslie Tayne, founder of Tayne Law Group. “When that debt is finally gone, you’ll feel lighter and more optimistic about your future.”

Advantages of paying off debt early

There are several advantages to paying off your debt early, and almost all of them translate into more money in your pocket each month and more financial freedom to address other goals.

Freedom from monthly payments

The more bills you have to pay, the more complicated and expensive your financial life can get. As you satisfy each of your debts, you’ll have one fewer obligation to meet every month. “As a result, your bill-paying process will become easier and faster, and you’ll get to keep more of your money in the bank,” says Tayne.

Save money on interest

When you have high-interest debt, such as credit cards or personal loans, it costs quite a bit of money just to make minimum payments each month. In addition, each month that you carry a balance on the account, the previous purchases you made become more expensive due to compound interest. “But, if you pay off the debt in full, you can save a lot of money in interest payments you won’t have to make,” says Tayne.

Improve your credit profile

When you pay off debt, it decreases your credit utilization ratio, which is the amount of debt you owe relative to the total amount of credit you have access to overall. Reducing your utilization ratio typically improves your credit profile and credit score. As a result, you will likely have access to more favorable interest rates in the future.

“The FICO credit scoring model encourages borrowers to keep their credit utilization ratio at 30% or less,” says Tayne. “That means if you have a $1,000 credit line between your revolving credit accounts, you should keep your total balance owed at or below $300.”

Increase your savings account

One of the biggest advantages of paying off debt is the spare cash you will now have available to address other financial goals and priorities. Ideally, you will use some of the money to increase your savings account, which can help avoid falling into debt again in the future. “If you have a surprise bill, you can cover it without using your credit card and repeating the debt cycle,” says Tayne.

Disadvantages of paying off debt early

It’s usually a good idea to try and pay off your debt as soon as possible, but there are certain situations when it doesn’t make sense. If you receive a large sum of money and put it toward your debt, you won’t be able to invest it and earn interest on it. It might make more sense to put that money in an emergency fund or invest it in a high-interest savings account instead.

Additionally, some loans have penalties for early repayment. Know whether your loan comes with this type of hefty financial penalty before paying off the loan early. It may be wiser to put the money into an interest-bearing account instead and continue to make monthly payments toward your loan rather than pay these types of unnecessary early payoff penalties.

Carefully consider where the money is coming from before using it to pay off your debt. If the money is in savings for emergencies it may not be wise to deplete that fund, especially if it puts you in a position where you’ll be more likely to use a credit card and rack up new debt at a high interest rate.

How to pay off debt early

If you’re considering paying off a loan early, there are a few ways to go about it. You don’t necessarily have to make one giant payment. It might be smarter to pay it off sooner with other methods.

Pay extra when you can

One of the most effective ways to pay off your debt before it’s due is to pay more than what you owe when you can. Start by paying more than the minimum amount each month, but only when you have the extra money to spare. Make sure you still have sufficient funds to cover rent, food, childcare, transportation and other daily expenses.

Paying more than the minimum is the only way you’ll make a dent in your debt because it will offset the interest you’re accruing. For example, if the minimum amount is $150, pay $300 when you can instead while still maintaining the monthly minimum when funds are tight.

For example, if you receive a work bonus in December, use that money to make an extra payment. Keep in mind that the more you owe and the longer the term of the loan, the more you’ll benefit from making an extra payment.

Make bi-weekly payments instead of monthly

Putting money toward your debt on a bi-weekly basis may make you more accountable than a monthly payment schedule will. This method isn’t the fastest way to pay off your loans, but it’s manageable for most people and will help reduce the amount of interest you’re paying. If you switch to a bi-weekly payment plan, you’ll have made the equivalent of one extra payment every year.

Look into lender payment programs

Some banks and loan providers offer special programs designed to help borrowers pay off their debt more quickly. Keep in mind, though, that these programs can come with additional fees. Still, lender payment programs can be worth the hassle or extra money in some situations. You could also look into a debt management program through a credit counseling agency if you find yourself deep underwater.

The bottom line

If you’re struggling with mounting debt, it’s not too late to take action. Create a budget, live within your means and do your best to avoid taking on more debt. In most cases, it’s best to focus on paying off one debt at a time.

If you have student loans, mortgage and credit card debt, figure out which one has the highest interest and work on paying off that one first (hint: it’s likely your credit card). That can keep you from accumulating debt elsewhere or paying too much toward your debt and being unable to pay for necessary expenses like rent.

The first step to financial freedom is repaying your debts as soon as you can. Luckily, there are dozens of resources at your fingertips to help you take charge of your financial situation and live debt-free.