The Pros and Cons of Paying Off Your Loans Early | Blog (2024)

FAQs

What are the pros and cons of paying off loans early? ›

Pro: You may improve your credit profile. Pro: You will have more freedom from debt. Con: You might starve an investment to feed your debt. Con: You might be penalized.

If you have federal student loans and pay them off early, you could lose the opportunity to take advantage of a student loan forgiveness program (if you qualify). If it's still worth it to you to pay off your student loans quickly, it may help to refinance your student loans as part of the process.

Pros of Paying Off a Personal Loan Early

With loan payments out of the way, you free up money to pad your monthly budget. You may have more funds to direct to another financial goal, such as investing, saving for a down payment or just having more "fun money," Nitzsche says.

If you pay off your mortgage early, you'll no longer have any mortgage interest to deduct on your tax return if you itemize your deductions. This change is most likely to affect you if you have a large mortgage, a high interest rate—or both—-and your annual interest payments are substantial.

Save money on interest

The more money you add to your payments and the higher your loan amount, the more you can save. Interest is typically spread out over the loan term. You'll pay less interest by paying off your loan early since the lender will have less time to collect interest from you.

It May Negatively Affect Your Credit

It's common thinking that paying off any debt can only be good for your credit, but paying off some debts early might actually have the reverse effect.

There are many benefits to paying off your student debt early. You will save on student loan interest and get out of debt faster while improving your debt-to-income (DTI) ratio. With a higher DTI ratio and more disposable income, you could pursue other financial goals, such as buying a house or saving for retirement.

Paying off your student loans could also benefit your credit score. Notably, it could improve your payment history, as consistently making on-time payments on your student loans helps establish a strong payment history.

There is a downside, however, if you're paying all of your loans off at once: That's one less deduction you'll be eligible for going forward. Deductions reduce the amount of your income that's subject to tax, which directly affects how much you owe or the size of your refund if you normally get one.

Paying off a loan early could save you money in the long term as it can reduce the total amount you need to repay. Bear in mind that you need to account for any early repayment charges to help decide if it's the right choice for you.

Should I pay my loan off early or invest? ›

Investing and paying down debt are both good uses for any spare cash you might have. Investing makes sense if you can earn more on your investments than your debts are costing you in terms of interest. Paying off high-interest debt is likely to provide a better return on your money than almost any investment.

You should consider pre-closing your personal loan when you have sufficient funds to pay it off without compromising your emergency savings or other financial goals.

For guaranteed savings and the security of owning your home debt free, paying off your mortgage earlier is a better option than investing your extra cash.

You should aim to be completely debt-free by retirement, and after age 45 you can begin thinking more seriously about pre-paying your mortgage. The opportunity cost of paying off your mortgage before investing for retirement is very high when you are young.

If you can afford to make extra payments, overpaying your mortgage means you pay less interest in the future and pay off your mortgage sooner. This means you could save a lot of money.

However, there are some typical models for determining penalty cost. Percentage of remaining loan balance: The lender will assign a small percentage, such as 2%, of the outstanding principal as a penalty fee if the payoff is made within the first 2 or 3 years of the loan term.

Almost every type of loan can be paid off early, and there are many benefits for doing so. It can save you money. It can improve your credit score (though not always). It can provide peace of mind.

There's no denying that paying off your home loan quickly will help reduce the total amount you spend on interest, but it's not necessarily a bad thing to maintain your mortgage for its full term if you put those additional funds to good use.