Paying Off Debt Early: Pros and Cons

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Key takeaways

Prioritize paying down high-interest debts first to save money in the long term.
It’s important to continue to save to earn compounding interest.
Debt repayment strategies can help you get out of debt faster and save on interest.

The pros and cons of paying off debt early are important to consider before you dive headfirst into accelerating your repayment plan. While eliminating debts ahead of schedule can seem like the obvious choice, it’s not always that simple. Yes, you may be able to save on interest payments, lower your monthly bills, and have a weight lifted, but you may miss out on building an emergency fund or saving for retirement.

Let’s explore the benefits and potential downsides of early debt repayment to help you decide if it’s the right choice.

Should you pay off your loan early?
When you should pay off debt before saving money
The pros and cons of paying off debt early
Pros and cons of saving money first
Can I save money and pay off my debts at the same time?
Why do you need a debt repayment strategy?
What are some debt repayment strategies?
Bottom line

Should you pay off your loan early?

Deciding whether to pay off your loan early is a significant financial decision that requires careful consideration. While the idea of not owing any money is appealing, there are disadvantages of paying off debt. It’s essential to evaluate your overall financial situation and goals.

Less stress, improved health

Having less debt can significantly lower stress levels, contributing to improved mental and physical health. The peace of mind that comes with eliminating a financial burden can be a powerful motivator, even if it means sacrificing potential earnings from other investments.

Do you have other high-interest debts?

Before focusing on paying off a specific loan early, consider whether you have other high-interest debts, such as credit card debt. High-interest debts can quickly accumulate, costing you more in the long run compared to the interest saved by paying off low-interest personal loans early. If you’re juggling multiple accounts, it may be wiser to use your extra funds to pay off higher-interest obligations first. A payoff calculator can help you compare different scenarios and identify the most cost-effective strategy for becoming a debt-free debtor.

Is there a prepayment penalty

Some lenders apply a charge when you settle your loan before the agreed term. This is because they make most of their money off of interest. If you pay the loan off before the agreed upon term, they lose money. A prepayment penalty allows them to make up for the interest they would have earned. The penalty could cancel out any interest savings you’d gain by settling the loan sooner. It’s pretty easy to find personal loans without a prepayment penalty.

What type of debt do you have?

There is a big difference between paying off a student loan early vs. a payday loan. Payday loans have notoriously high interest rates, and so should be paid off as soon as possible. Other loans, like student loans, personal loans, and mortgages, tend to have lower interest rates, so paying them off early is less of a concern.

Credit cards tend to have high interest rates. Paying off your credit card balance in full is usually a very good idea. Then, settle other debts.

Freedom to pursue other life goals

Paying off a loan early can give you the financial freedom to pursue other goals, such as buying a home, starting a business, or traveling.

Does paying off the loan align with your financial goals?

Early repayment might make sense if your primary goal is to not owe money. However, if you’re focused on building wealth or saving for retirement, you might find that investing extra money elsewhere yields a better return.

Could you earn more money elsewhere?

One critical consideration is whether you could earn a higher return by investing your own extra cash in funds rather than paying off your loan early. For instance, if your loan has a low-interest rate, you might benefit more from investing in the stock market, your 401 (k), or other opportunities that offer a higher rate of return. Carefully weigh the potential earnings against the interest saved by paying off the loan early. A payoff calculator can help you estimate the savings from early repayment and compare them to potential investment returns.

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When you should pay off debt before saving money

Deciding whether to focus on debt repayments or saving money can be challenging. Both are very important to your financial health. The general advice is to strike a balance.

Are there other financial priorities you should consider?

Before you start aggressively paying off your debt, evaluate other financial priorities that may require immediate attention. For example, if you have high-interest credit card debt, it often makes sense to tackle that first, as the interest charges can quickly outweigh the benefits of saving. Additionally, if you have upcoming large expenses, such as a major home repair or medical bills, it might be wise to allocate more cash toward these needs to avoid borrowing later.

Emergency fund

Building an emergency fund is crucial. Ideally, you should have at least three to six months’ worth of living expenses saved before aggressively repaying creditors. This safety net ensures that unexpected expenses, such as job loss or a medical emergency, don’t mean you have to borrow even more money. If you don’t have an emergency fund, prioritize building a modest one first. Put any extra cash into a high-yield savings account and set it aside for a rainy day. A high-yield savings account ends up paying interest to you instead of the other way around. Not only will you save money, but you’ll be earning money too.

Balancing debt payoff with emergency savings helps ensure you’re financially prepared for both expected monthly expenses and unexpected ones too.

The pros and cons of paying off debt early

Paying off debt sooner can offer significant advantages, but it’s not without its drawbacks.

Pros:

Save money on interest by decreasing the total amount paid over the life of the loan.
Reduce debt-to-income ratio, which improves your financial health.
Unlock extra money for alternative financial goals or investment opportunities.
Gain peace of mind and reduce financial stress.

Cons:

Lose the chance to invest in opportunities that could provide higher returns than the interest you save.
Unable to build an emergency fund or reach savings goals
Depletes your cash flow and limits your ability to handle unplanned expenses.
Potentially incur prepayment penalties, depending on the terms of your loan.
May reduce your credit mix, which can hurt your credit score.

Pros and cons of saving money first

Choosing to save before paying off your debt can be a smart financial strategy, but it comes with its own set of pros and cons.

Pros:

Build a financial cushion, such as an emergency fund, to protect against unexpected expenses.
Take advantage of compounding interest from a high-yield savings account to grow your wealth over time.
Maintain flexibility and financial security by having readily available savings.

Cons:

Incur more in interest payments if high-interest debts are left unpaid.
Slower progress which could prolong financial stress.
The cost of carrying outstanding debts may outweigh the benefits of accumulating savings.

To save or pay off debt?

Learn more about how you can strike a balance.

Can I save money and pay off my debts at the same time?

Yes, it is possible to save money and pay off your debts simultaneously, and for many debtors, this balanced approach is often the most effective strategy for long-term financial health.

Making extra payments: a balanced approach

One way to achieve this balance is by making extra payments toward your outstanding balances while still setting aside a portion of your income for savings. For instance, you might allocate 5% of your income to a high-interest savings account and 15% to debt payments. This strategy allows you to reduce the total interest paid over the life of your loan while still growing your savings.

Why do you need a debt repayment strategy?

A debt repayment strategy helps you effectively and efficiently pay off your debt. Without a clear plan, it’s easy to become overwhelmed by multiple payments, high-interest rates, and the sheer burden of debt. A well-thought-out strategy helps you prioritize which debts to pay off first, provides structure and discipline, and makes it easier to stay on track.

What are some debt repayment strategies?

There are plenty of repayment strategies. Choosing the right one depends on your personal loans and situation. Here are some of the most common methods to consider, each with its advantages and potential drawbacks.

The snowball method

The snowball method prioritizes paying off your smallest debts first without considering the interest rate. Make minimum payments on all accounts, focusing any extra funds on paying off the smallest balance. Once you have that debt paid, you move on to the next smallest balance. This method can be highly motivating, allowing you to see quick wins and build momentum.

The avalanche method

The avalanche method, on the other hand, aims to tackle the debts with the highest interest rates first. You make all the minimum payments but direct any extra funds toward the balance with the highest interest rate. As you pay down your debts that rack up the most interest, you save money. The avalanche method is the most cost-effective option.

Debt management plans

Debt management plans (DMPs) are arranged through credit counseling agencies, which work with your creditors to reduce interest rates, waive fees, and establish affordable monthly payments. DMPs do not reduce the principal amount owed but can make repayment more affordable by lowering interest rates and extending repayment terms. This strategy is good if you need assistance, can afford monthly payments, and want to avoid more drastic measures like bankruptcy.

Does a DMP sound like the perfect solution?

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Consolidate your debt

Debt consolidation merges multiple debts into one loan or balance transfer credit card, usually with a lower interest rate and more manageable payment terms. A single credit card balance or loan makes managing your finances easier since you’re only responsible for one monthly payment.

Is debt consolidation a good idea for your specific situation? While it can provide immediate relief, it may extend the repayment period and increase the total amount paid over time if the debt consolidation loan or card is not managed carefully.

Debt settlement

Debt settlement involves negotiating with your creditors to pay your outstanding balances in a lump sum that is less than the full amount you owe. While this can reduce the total owed, it will negatively impact your credit score, has tax implications, and not all creditors will agree to a settlement. A debt settlement lump sum can be a viable option if you’re struggling to make even minimum payments and have overwhelming bills, but it should be approached with caution.

Bankruptcy

Bankruptcy is a legal process that can provide relief if you are unable to pay all you owe. There are 3 types of bankruptcies commonly considered by individual debtors: Chapter 7, Chapter 11, and Chapter 13. Chapter 7 involves liquidating assets to pay off creditors, while Chapter 13 allows for the restructuring of debts into a manageable repayment plan. Chapter 11 is typically used by businesses but can also apply to individuals with complex financial situations. While bankruptcy can offer a fresh start, it has long-lasting consequences on your credit and financial future, so it should be considered only as a last resort.

Each of these debt repayment strategies has its benefits and potential downsides. The best choice depends on your financial situation, the types of debts you have, and your long-term financial goals.

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Frequently asked questions

1. Is there a downside to paying off debt?

While debt payoff is generally positive, there can be downsides. Paying off debt early might divert funds from other financial priorities, such as saving or investing, potentially leading to missed growth opportunities. Additionally, if you pay off a low-interest loan but have higher-interest debts, you might end up paying more in the long run. Good money management requires you to balance both paying debts and saving.

2. What happens when you pay off all your debt?

You gain more financial security and money every month, allowing you to save, invest, or spend more freely. Your credit score may also improve as your debt-to-income ratio decreases.

3. Should you pay off debt or keep money in savings?

It depends on your financial situation. If you have high interest credit card debt, paying it off first may save you more in the long run. However, maintaining a savings cushion is crucial to avoid accumulating more debt in an emergency. Balancing debt payoff with saving is often the most prudent approach.

4. Is it better to be debt-free?

Not owing money offers significant advantages, such as financial stability, reduced stress, and the ability to allocate funds toward retirement savings, investments, or other goals. However, not all debt is bad—low-interest debt, like a mortgage, can be manageable and even beneficial. Ultimately, the goal is to be free from high-interest, burdensome debt.

Bottom line

Deciding whether to pay off debt early or focus on savings is a deeply personal decision. For some debtors, the peace of mind and financial freedom of debt payment outweigh other considerations. For others, investing, saving, or pursuing other financial goals may be more beneficial before aggressively tackling debt.

The key is to clearly understand your financial situation, including the types of debt you carry, their interest rates, and your long-term goals. Tools like payoff calculators and guidance from a wealth advisor can help you make informed decisions and strike a balance between debt payments and savings.

Ultimately, the best approach aligns with your monthly budget, reduces stress, and helps you achieve long-term financial stability. By carefully weighing the pros and cons, you can create a plan that empowers you to become debt-free sooner with saving.

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Rachel Alulis

Rachel Alulis has been the lead editor for Moneyfor’s credit cards team since 2015 and for the financial rewards team since 2023. Before joining Moneyfor, Rachel worked at USA Today and the Des Moines Register. She then established a successful freelance writing and editing business specializing in personal finance. Rachel holds a bachelor’s degree in journalism and an MBA.