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Being in debt is not the financial situation you want to be in.
Because of this, many people in debt look to pay it off early.
But is always the right move?
In this post, I’ll walk you through the pros and cons of paying off debt early so you can decide if this makes the most financial sense for you.
Table of Contents
13 Pros And Cons Of Paying Off Debt Early
Pros Of Paying Off Debt Early
There are many advantages of paying off debt early. Here are the biggest ones to consider.
#1. Save On Interest
The biggest benefit is the interest savings you will experience.
The interest charges you pay on your debt only makes the items you originally bought that much more expensive.
For example, let’s say you went on a shopping spree and charged $2,500 worth of clothes to your credit card that has an interest rate of 18%.
You feel great because you found some amazing deals on these clothes.
But when the credit card bill comes due, you only make the minimum payments.
If you keep doing this, by the time you pay off your new clothes, you will have paid close to $6,000 in interest costs!
All that hard work went for nothing as you could have bought more than double to the amount of clothes with this money.
The point is, interest charges add up and can derail your future.
By paying off your debt as quickly as possible, you lower the destruction that can happen to your money.
#2. Start Building Wealth
Another advantage is the sooner you get out of debt, the sooner you can start building wealth.
And the more time you allow your money to grow, the more it grows into thanks to compound interest.
- Read now: Learn the power of compound interest
For example, let’s say you work hard and put extra cash towards your debt through additional payments.
You then take $500 a month and invest it for 25 years earning 8% annually.
It grows into close to $474,000. Now let’s say you take your time paying off your debt and it takes you 10 more years to become debt free.
You take the same $500 and invest it, earning 8% annually.
But you only invest it for 15 years since you took longer to pay off your debt.
This money grows into close to $176,000.
Those 10 years cost you almost $300,000!
The bottom line is, the longer you wait to pay off your debts, the less wealth you can build for other financial goals.
- Read now: Here are 15 steps to building wealth
#3. Financial Stability
Even before you start working to build wealth, you can improve your financial foundation when you eliminate your debt.
This means establishing an emergency fund to cover shorter term surprise expenses.
Or putting money in a savings account for upcoming goals like a vacation or even paying irregular bills.
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By having cash reserves, you can better handle what life throws at you, and aren’t likely to fall back into the trap loan payments again.
#4. Increased Credit Score
Having a mountain of debt is not good for your credit score.
When your credit utilization ratio is high, your credit score suffers.
And when you have many loans and credit card bills to pay, you risk paying late.
This also can impact your credit score.
- Read now: Find out the steps to improve your credit score fast
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But if you pay off debt early, your credit utilization ratio goes down.
This is because you are using a smaller percentage of your available credit limit.
By keeping this ratio in check, you will see your credit score rise.
And when you have a high credit score, it means creditors view you as less risky borrower.
This translates in lower interest rates when you need to borrow money again, saving you money and making your monthly payments smaller.
#5. Peace Of Mind
If you are in debt, you know the impact it has on your mental health.
You worry when you get the mail if a bill will be there.
You question how you will survive financially for the month, wondering how you will pay for groceries or gas.
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You fear a surprise bill or an unexpected expense popping up.
The bottom line is, it isn’t enjoyable to live a life of debt.
By getting rid of your debt, all this worry, stress, and fear goes away.
Your mental health improves and you enjoy life more.
- Read now: Discover the joys of debt free living
#6. More Options In Life
Finally, being debt free gives you more options in life.
For example, let’s say your debt payments total $700 a month.
If you made extra payments to get rid of these payments, you now have $700 to put towards retirement or a vacation, or even towards a down payment on a house.
You might even consider quitting your job and doing something you love, even though it pays less.
This is because without the debt payments, you can afford to live on a lower salary.
And having financial freedom in life makes life much more exciting and fun because you never feel like you are missing out or need to hold back because you have to pay all these bills.
Cons Of Paying Off Debt Early
As great as the benefits listed are, there are drawbacks to paying off debt early. Here are the ones to consider.
#1. Can Take A Long Time
One of the biggest drawbacks of paying off debt early is it takes time.
You aren’t going to be debt free overnight.
It likely took you years to build the debt you are in, and it will take years to get out too.
This can be demoralizing to many people, and as a result, they give up along the way.
To overcome this, you need to have a plan.
The best plan for many is the debt snowball.
It has you pay off your smallest debt to first to keep you motivated along your journey.
#2. Opportunity Cost
When getting out of debt early, you are putting extra money every month towards your bills.
This is money you could otherwise use for other things.
So you have to consider the opportunity cost of paying extra.
You have to look at your monthly budget.
Putting more of your monthly income towards your debt is going to impact your cash flow.
For example, if you put an extra $100 towards your credit card bill, this means you can’t use the money for a night out with friends.
This isn’t to say you should not pay extra on your debt, but you have to find a balance with the cost.
For me, when I was trying to pay off my credit card debt, I put all my money that was not paying bills towards my debt.
I quickly resented my debt because I wasn’t going out with friends or enjoying life. I had to reassess and find a happy medium.
#3. Need To Get To The Root Problem
Here is something many people don’t do, and it costs them.
They never address the real problem of why they are in debt.
Many think they simply are bad with money or have a spending problem.
So they pay off debt and then a few years later are right back where they started.
Most people aren’t just bad with money.
Usually they are overspending to make up for other issues in life.
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Maybe they hate their job, or their relationship isn’t working out.
Maybe they aren’t as successful as they think they should be.
Or they might see their friends getting ahead and feel jealous.
Until they tackle these issues, no matter how quickly they pay off their debt, chances are they will find themselves right back in debt soon.
So before you decide to pay extra, make sure you address the elephant in the room.
#4. Might Have To Get A Second Job
Another drawback of paying off debt early is you might have to get a second job.
This isn’t always the case, but often times people need to find ways to bring in more money to speed up the process of getting out of debt.
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If you are already working a lot and don’t want to work more, this can be difficult.
Plus, spending more time working means less free time doing the things you love.
Again, this isn’t to say you shouldn’t pay off your debt, but it is something to consider.
#5. Smarter To Keep Low Interest Debt
Financially speaking, there are valid arguments for keeping some low interest debt and paying off higher interest debt.
This is because you can build wealth by investing the money instead.
To understand this, you need to look at the interest rate you are paying.
Most credit cards have higher interest rates, around 17%.
When you pay extra, you are saving the 17% interest you would otherwise pay.
So this is a 17% return on your money.
There are very few places you can invest that will give you this rate of return.
On the other hand, your mortgage might have an interest rate of 3.5%.
While it would be great to not have a mortgage payment, there are many places you can invest your money and earn more than 3.5% on your money.
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Therefore, it is advised that you invest your money and just pay the minimum on your mortgage.
Here is a quick breakdown of types of high-interest debt to pay off sooner.
- Credit card debt
- Auto loan
- Personal loan
And here are debts you might want to take more time to pay off.
- Student loan
#6. Tax Deductions
When it comes to your home loan, the mortgage interest you pay can be deducted from your income tax return, saving you money.
The same is true for student loan debt.
To make sure you are saving money, you want to see how making extra mortgage payments or an extra student loan payment will impact your taxes.
The easiest way to do this is to look at the total amount of interest you pay in a year and multiply this by your income tax bracket.
For example, if the amount of interest you paid is $5,000 and are in the 20% tax bracket, you lowered your taxable income by roughly $1,000.
This is just a rough estimate of your tax deduction as other credits and deductions can have an impact.
With this said, don’t make the mistake that many others do and think you get to deduct the entire amount of interest from your taxes. You can only use a percentage of the interest paid.
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#7. Prepayment Penalty
Another thing to pay attention to is if any of your debt has prepayment penalties.
Some types of loans charge you a fee if you pay more than what is required.
So if you decide to make larger payments, it could end up costing you more money.
Before you make any extra payments, review the terms of your loan to make sure there aren’t any penalties for paying more.
There are 10 pros and cons of paying off debt early.
At the end of the day, you have to look at your situation and financial goals and decide what financial decisions make the most sense for you.
For example, it is financially the right thing to not pay extra on your low interest mortgage and invest the money instead.
But if the peace of mind of not having a mortgage payment is more important to you, then pay off your mortgage.
You need to really decide what will make you happiest and help you succeed in life and then follow that path.
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I have over 15 years experience in the financial services industry and 20 years investing in the stock market. I have both my undergrad and graduate degrees in Finance, and am FINRA Series 65 licensed and have a Certificate in Financial Planning.
Visit my About Me page to learn more about me and why I am your trusted personal finance expert.