Debt is a major financial burden for many borrowers today. But do you still know why you should not miss the opportunity to pay off your loan early and save or make money from your existing loan?
This may surprise many people, but completing debt repayments ahead of schedule is one of the major mistakes that many borrowers make after repayment. While the idea of getting debt-free early is appealing, there are reasons to avoid paying off your financial debt early, even if you can afford it.
In this guide, we’ll explain why you should think twice before proceeding with your loan payments. Read below for more tips on how to jumpstart your debt lifeline.
Why do people pay off their loans early?
Paying off your debt early and in full isn’t the worst thing to do after taking out a loan. Doing so provides the borrower with many benefits that improve their financial situation.
For example, eliminating your monthly mortgage payment will ease your cash flow and allow you to spend more on necessities like rent, bills, food, and other necessities. You can also save on interest on your debt by making early repayments. The lower your monthly payments, the less interest you pay and the better you can build up your funds.
Additionally, if you take out a loan against a property and pay it off early, you will take full ownership of it. For example, if you take out a mortgage and find yourself in a difficult situation, you can protect your home from foreclosure.
Finally, paying off debt early gives borrowers peace of mind. Since there is no need to take out a loan, you will be freed from the anxiety of financial burden.
Reason: Why shouldn’t you pay off your loan early?
Despite these benefits, sticking to a monthly payment schedule is better than paying off your debt in full early. If you have enough funds to cover the entire loan, read the reasons below before doing so.
1. Build an emergency fund first.
An emergency fund is essential to ensure financial security in unforeseen circumstances. Events such as medical emergencies and repairs can occur when you least expect it. Without a safety net, you may end up increasing your financial burden by depleting your savings or taking out more loans at higher interest rates.
It’s better to build an emergency fund before diverting large amounts of debt. That way, you can address urgent needs that require large amounts of money without affecting your monthly budget or savings.
Financial experts often recommend saving three to six months’ worth of living expenses when building an emergency fund. You should also set realistic goals based on your current financial situation. Consider your monthly payments and necessary expenses. Next, find workarounds that allow you to set aside money in your emergency fund.
If you find it difficult to save a large amount of money on top of your current expenses, you can start small. Start with manageable contributions. It then increases over time as you reduce your mortgage payments and improve your financial situation.
2. Pay off high-interest debt immediately.
Always remember that not all debt is created equal. Some of them have high interest rates, and if left unchecked, they can accumulate and become a bigger financial burden. Prioritizing these high-interest debts is a better option than paying off one loan all together. Direct your resources to eliminate them first to save on interest payments.
It’s also worth noting that timely payments and reducing high-interest debt can have a positive impact on your credit score. Addressing or completing these loan obligations early can help increase your chances of accessing favorable terms on future loans.
3. Avoid prepayment penalties
Prepayment penalties are one of the most important reasons to take a break before paying off your mortgage early. What you may not know is that these are fees charged by lenders and similar parties when a borrower repays a loan before the scheduled repayment period.
Lenders and similar financial institutions impose prepayment penalties on borrowers to protect them from the risks associated with early payment of a loan. It is designed to compensate these parties for the potential loss of interest income that they would have earned had they continued to make payments according to their original terms.
These penalties are standard for fixed rate mortgages and personal loans. If you plan to pay off your loan early, it’s important to learn more about prepayment penalties before proceeding. The good news is that many lenders are willing to negotiate or waive prepayment penalty terms. However, such options are only available before taking out the loan and not during repayment.
4. Earn more with your investments
Another big reason to avoid paying off your loan completely is the potential for higher returns through strategic investments. You can use the money you save to invest in stocks or start a business.
Through this idea, you can make more money and create a self-sustaining fund, which can be more than the amount you save on a loan advance.
On the other hand, if you are planning to invest, as mentioned above, be sure to prioritize your emergency fund and personal savings before investing. Once you have dealt with these costs and achieved your goals, you can consider profitable investments.
5. Avoid losing tax credits
It’s important to know that interest payments on certain loans are tax deductible. Debts such as mortgages and business loans are often deducted from your annual taxes, significantly reducing your taxable income for the year. If you pay off your loan in full, you may lose these potential tax benefits.
If you want to pay off your loan early, talk to a tax professional to learn more about the tax implications of your debt. If you find that your loan is tax deductible, delay paying it off completely so you can save even more from such programs.
6. Increase your retirement benefits
Finally, rather than using the funds you accumulate to eliminate existing loans, you can use the money to build your retirement savings early. Ideally, you should prioritize retirement even before you reach that age because of the compounding effect.
Compound interest is when interest accumulates over time, significantly increasing the total value of your funds. In other words, the sooner you start donating, the more time you have to raise funds. Doing so will create a fuller nest egg to use in retirement.
The best time to pay off your loan early
As mentioned above, prepaying a loan can benefit some borrowers. If you approach this process properly, you have the advantage of getting your loan processed sooner than expected.
To help you manage your debt, we’ve listed below some best practices to consider when paying off your debt early. Read below for more information.
1. Check your payment details.
The easiest way to increase your debt lifeline is to split your monthly payment into two biweekly payments. This is a great way to avoid rising interest rates by applying for additional payments.
For example, if your minimum monthly payment is $500, you can split it into $250 per month. Try adding an extra $50 to your principal balance to continue paying down your loan while still getting the credit benefits of regular payments.
On the other hand, it may be helpful to check with your lender first before making this change. Always keep in mind that some financial institutions may have stricter repayment plans or penalties for early repayments.
2. Increase payment sources
Consider supplemental financial sources like bonuses, commissions, and similar incentives throughout the year to pool funds that allow for higher monthly payments.
It can also help you cut down on additional expenses, such as eating out less or buying unnecessary items throughout the year.
By making a few changes to your spending habits, you can make room in your budget for additional debt payments. However, this step should only be performed if you have the aforementioned sources or if you can save money. Don’t reduce your budget for essentials just to pay off your loan faster.
3. Add additional sources of income
As mentioned earlier, some borrowers choose to use the accumulated funds to invest in businesses or stocks instead of repaying the loan in full. That way, you’ll be able to handle more expenses separately from your existing debt. If that’s not your best option, consider taking on a side hustle to earn extra income and speed up the repayment process.
Having a second gig is becoming increasingly popular around the world. According to a report from Yahoo Finance, 50% of Americans today have a side hustle even though they already earn a significant income each month.
Nowadays, there are many side hustles that you can try to earn more from your loan. Freelance writing, tutoring, pet care, and selling handmade items are the best options.
On the other hand, if you’re starting a side hustle, make sure to allocate your funds to daily expenses, savings, and an emergency fund before you start paying off debt early.
4. Take time to review your budget
Creating a monthly budget is a great way to organize your finances and identify opportunities to save more. Unfortunately, that can be difficult to maintain, especially with the continued changes and challenges in today’s economy.
Always take the time to review your budget and make sure it covers all your expenses. By doing so, you can identify whether there is room for adjustments or improvements and ensure that you are able to pay off your debt on time. Reviewing your budget can also help you determine if you can reduce your loan lifeline by paying more.
Fortunately, there are a variety of resources and tools available to help you improve your current budget. You can also seek the advice of a financial advisor for a better strategy.
5. Consider refinancing your loan
Another way to shorten the life of your debt is to refinance. Loan refinancing allows a borrower to replace an existing loan with a new loan with more favorable terms. This can help borrowers secure lower interest rates, lower monthly payments, or change their debt lifeline.
This option is available for a variety of loans, including mortgages, auto loans, and student loans. Refinancing your loan can improve your overall financial situation by offering you better terms, giving you more flexibility in paying down your debt.
On the other hand, refinancing your loan isn’t always the best choice in every situation. You should only continue with this strategy if you can achieve a lower interest rate than your previous loan or get better terms than your previous loan. If you don’t, you’ll end up taking out a new loan at a similar interest rate. Check your lender’s terms before choosing to refinance to take advantage of this option.
6. Consolidate all your debts
Debt consolidation is similar to refinancing. This technique combines or consolidates multiple debts, including credit card balances and other similar loans, into a single, more manageable loan. This simplifies the repayment process and may result in more favorable terms, including lower interest rates.
Consolidating your debts allows you to streamline your obligations and better track your payments. In some cases, it may help reduce your total borrowing costs.
The only drawback to debt consolidation is that you will need a good credit score before taking advantage of this option. Borrowers typically need a score of 740 or higher to use this strategy. Anything in the 739-670 range is also fine. Scores lower than that are not suitable for debt consolidation.
Too early isn’t necessarily the key
There’s no denying the appeal of paying off your loan early. However, it may not always be the best choice for everyone. Debt often comes with favorable terms and other benefits, allowing the borrower to pay off the loan without incurring financial burden.
If you can build up the funds to pay off your debt in full, think twice before proceeding. You can use the money you save to build an emergency fund, invest in a business, or pay off other high-interest loans.
On the other hand, rather than paying off your debt completely, consider making additional payments or implementing other financial strategies to speed up your debt. Of course, before doing so, we recommend consulting with a lender or a professional to ensure you get the most advantageous plan for your current situation and abilities.