Pros and Cons of Paying Off Loans Early – U.S. News & World Report
- August 10, 2020
- By: Greenpath Financial Wellness
From U.S. News & World Report, Jeffrey Arevalo, financial expert at GreenPath Financial Wellness, provides insight about the pros and cons of paying off loans early.
A common question many people ask is if paying off loans early is a good option for borrowers.
It is possible that paying off loans early can add up to savings and freedom from debt. But do the benefits of paying off a loan before the term is up outweigh the drawbacks?
According to the article, the pros of paying off debt early include the following:
- Paying off a loan before it matures can save you money.
- You may improve your credit profile.
- You will have more freedom from debt.
The article also outlines the cons of paying off loans early:
- You might impact your budget or investmetns to feed your debt.
- You might be penalized.
The article looks closer each of the pros and cons, with insight from GreenPath.
Pro: Reduced Interest
Paying off loans early means there is less interest to pay over time. In particular, paying off high-interest debt can deliver significant interest savings. Once that debt is gone, you can allocate more money to savings.
When you pay off a loan, your account is closed in good standing. At this point, you have eliminated the risk to your credit score due to avoiding any late or missed payments.
Paying off loans early can also lower your debt-to-income ratio. This is a metric lenders use to make credit decisions. As an example, paying off an auto loan or a personal loan before you apply for a mortgage means you are likely to be offered better terms.
Pro: Keeping Debt in Check
Luckily, a growing number of people are waking up to the importance of keeping debt levels in check, says Jeff Arevalo, financial wellness expert at GreenPath Financial Wellness, a national nonprofit credit counseling agency in Farmington Hills, Michigan.
“One positive trend we’ve seen during the COVID pandemic is that people are spending less, which has, in turn, caused an increase in savings and a stronger push towards paying down credit card debt,” he says.
Con: Starving Investments to Feed Debt
Paying off a loan early can be a huge relief, but it shouldn’t come at the expense of larger goals, such as saving for retirement, making investments or funding college for your kids. Even more important is growing – or replenishing – an emergency savings cushion.
“We impress upon clients the importance of having emergency savings, no matter what,” Arevalo says.
If your finances are in good shape and you have enough savings to cover your expenses for six months, you can shift to aggressively paying down debt. That includes your mortgage.
“If you have a home loan and worry about what might happen during a recession – especially one involving declines in home prices – you should consider accelerating your mortgage payoff,” Arevalo says.
You may give up some gains from investing in the stock market – and miss the mortgage-interest tax deduction – but paying off your home loan early can strengthen your financial foundation.
Con: You Might Be Penalized
Sometimes paying off a loan early comes with a cost. Lenders may charge prepayment penalty fees.
Paying off a loan early saves on interest, but if the lender applies a penalty, those savings might be offset.
It is best to fully understand the terms of your loan before you pay it off.
GreenPath Is Here To Support You
When it comes to deciding on financial decisions like paying off debt early, support is available to you through a range of debt counseling services. Our financial counselors will work through your whole financial picture to help you identify options that can relieve financial stress.
Jeff Arevalo is a Financial Wellness Expert and has been with the Greenpath since 2006. He possesses a strong passion for helping others and takes great pride in providing strong financial education and effective money management tools to help make a difference in people’s lives. Jeff and his wife recently welcomed a baby boy to their family and are excited to navigate the world of parenthood for the first time.