When times are good (or good enough) and the money is rolling in, maybe due to a raise, windfall inheritance, holiday bonus, investment gone right or some other influx of cash, it’s easy to wonder: Should I pay off a debt early? After all, debt, we’re told, is bad. Carry it if you must, when you buy a house, car or take out student loans, but get rid of it as soon as you can.
But you shouldn’t necessarily pay off your debts early, many experts say. You could end up fixing one problem only to create another. So if you’ve ever wondered whether you should pay a debt off early, here are the pros and (a lot of) cons to ponder. In fact, for many people, paying off debts early isn’t the no-brainer you might think it is.
The pros. The main plus to paying off debt early is that you no longer have to fork over money to a lender; you’ll now have extra money to spend on other things. You can also potentially save a lot in interest payments.
In fact, according to a lifetime cost-of-debt calculator from Credit.com, a typical person will likely pay $279,002 of interest on credit purchases over the course of his or her life. And that’s assuming you have a fair credit score of 620 to 679. The crummier your credit score, the more money in interest you’ll pay throughout your life. And nobody wants that. If you can pay less money in interest, that’s the dream.
You also may avoid stress and anxiety by paying off a debt early. But that’s all pretty obvious. The negatives of paying off debt may not be as clear.
Con: You may lose some of the benefits of having debt. There are benefits? Yes, debt can have a bright side.
Rosie Brown, a creative project manager at a communications company in San Francisco, paid half of her student loans off in what she says was a move of impatience, and she quickly regretted it.
“I paid off a large chunk because of the weight that debt put on my mind, knowing I would owe so much money for the next 10 years or so. I thought if I could pay off a few of the loans, I could reduce my monthly payments and feel better.”
And so Brown took $15,000 from a college savings fund that her parents started when she was a baby, and used it to pay down $23,000 in student loan debt. While she didn’t do anything foolish — it isn’t as if she used the money to make bets on the horses — Brown regrets using the money to pay down that student debt.
The way she sees it, spending that $15,000 on student debt, instead of letting it sit in her checking and savings account, robbed her of several opportunities.
— Creating that credit history. Brown says the student loan payments are establishing a history of making loan payments on time.
— Having tax deductions. “More interest paid equals more tax deductions, though not by much, really,” Brown says.
— More cash flow. She would have had more cash flow “to invest without becoming more dependent on credit and borrowing,” Brown says. Plus, it isn’t as if the lenders were beating down her door, demanding her to pay off debt early. The extra time to pay off the loans and that money in the bank, Brown says, would have been “super helpful … as someone fresh out of college and just starting their career.”
Con: To feed your debt, you might starve a different fund.
Sure, maybe you fork over a lot of money at once and pay off your house, which would be a huge relief, but does that mean you’re going to fall behind on saving for retirement? Or funding your kids’ college?
Richard Kelleher, a digital marketer in Phoenix, admits that he regrets paying off his debt early every time he does it.
“I have tapped extensively into my retirement savings, which are about nil, and I have about 30 years to go, according to the doctor,” says Kelleher, who used the savings to pay down credit card debt and money owed to the IRS. “Yesterday, I paid off a $4,000 balance on a credit card that had no interest for another seven months. Why?”
Con: You might make more money by investing money.
If you play the long game, in the end, you could be better off investing and not paying down debt, says Elle Kaplan, CEO of LexION Capital Management in New York City.
“One misconception I need to clear up is that all debt is inherently evil. People often lump a home loan in with high-interest debts like credit cards. I call this clean vs. dirty debt — dirty debt should be tackled right away, but clean debt can be erased in the long term,” Kaplan says.
As a general rule, she does not recommend paying your mortgage off early. “A smart investment plan is very likely to outmatch any savings you’d get from paying off a home early,” she says. “You can calculate the potential savings in interest from early mortgage payments and tailor your investment strategy to exceed those savings.”
Con: You can’t ask the lender to send you the money back.
Sure, paying off a debt is the responsible thing to do, and paying it off early may be, in your case, the smart thing. But if you do pay off a debt early, it isn’t as if you can ask your lender a few days later to return that money. Yes, your debt is gone, which is great, but if you didn’t really think through the decision to pay off a loan early, you could be left with some regrets.
Brown says that if she could redo her decision to pay off so much of her student loans, she would.
“Instead, I would have reminded myself to be patient and enjoy having real cash as a buffer in my rainy-day savings or in a down payment for a new car,” Brown says.
And while Kelleher is probably being too hard on himself for paying down his debts, he thinks he sometimes pays off debts too early to his detriment.
“I know people who take trips to San Diego, go to Las Vegas and Hawaii regularly. I haven’t been out of Phoenix in seven years. I pay my bills,” Kelleher says. “That’s probably what they’ll put on my tombstone: ‘What a chump. He died with all his bills paid.'”
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