"In many cases, paying off a personal loan early will save the borrower money in interest," says Thomas Nitzsche, senior director of media and brand at Money Management International, a nonprofit credit counseling agency. With loan payments out of the way, you free up money to pad your monthly budget.
Paying down debt is generally a smart financial move. But there are certain situations when you might choose to continue making regular payments on a personal loan rather than pay it off early.
Reducing your interest is always good. Paying off a $160,000 loan with a 4% interest rate in 30 years means interest is approximately $115,000. Paying it off in 15 years brings interest down to around $53,000 – a saving of just over $61,000.
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.
Bottom line. If you have a credit card balance, it's typically best to pay it off in full if you can. Carrying a balance can lead to expensive interest charges and growing debt.
The Takeaway
The 15/3 credit card payment rule is a strategy that involves making two payments each month to your credit card company. You make one payment 15 days before your statement is due and another payment three days before the due date.
Budgeting difficulties
Another disadvantage of being paid monthly is that it can be more difficult to budget. Employees may have to wait a full month before receiving another wage payment, making it difficult to manage expenses that occur throughout the month.
Interest rates play a pivotal role in the decision-making process. If you're dealing with high-interest Debt, the total amount you'll pay can be substantially higher if you opt for gradual payments. In such cases, paying off the Debt can result in significant savings.
Even one or two extra mortgage payments a year can help you make a much larger dent in your mortgage debt. This not only means you'll get rid of your mortgage faster; it also means you'll get rid of your mortgage more cheaply. A shorter loan = fewer payments = fewer interest fees.
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings. The savings category also includes money you will need to realize your future goals. Let's take a closer look at each category.
They stay away from debt.
One of the biggest myths out there is that average millionaires see debt as a tool. Not true. If they want something they can't afford, they save and pay cash for it later. Car payments, student loans, same-as-cash financing plans—these just aren't part of their vocabulary.
A recent GOBankingRates survey found that the majority of Americans (51%) currently have over $5,000 in non-mortgage debt, with 18% having between $5,000 and $10,000, 10% having between $10,000 and $20,000, 10% having between $20,000 and $50,000, and 13% having over $50,000 in debt.
You might get hit with a prepayment penalty.
Check your loan documents carefully and do the math before making your decision. Though you'll save on interest, a prepayment penalty could partially or entirely wash away those savings, especially if your loan already has a low, fixed interest rate or a shorter term.
Pay off your debt and save on interest by paying more than the minimum every month. The key is to make extra payments consistently so you can pay off your loan more quickly. Some lenders allow you to make an extra payment each month specifying that each extra payment goes toward the principal.
Paying off debt might lower your credit scores if removing the debt affects certain factors such as your credit mix, the length of your credit history or your credit utilization ratio.
If you pay $100 extra each month towards principal, you can cut your loan term by more than 4.5 years and reduce the interest paid by more than $26,500. If you pay $200 extra a month towards principal, you can cut your loan term by more than 8 years and reduce the interest paid by more than $44,000.
Options to pay off your mortgage faster include:
Bi-weekly payments instead of monthly payments. Making one additional monthly payment each year. Refinance with a shorter-term mortgage.
Making extra payments of $500/month could save you $60,798 in interest over the life of the loan. You could own your house 13 years sooner than under your current payment. These calculations are tools for learning more about the mortgage process and are for educational/estimation purposes only.
Why credit scores can drop after paying off a loan. Credit scores are calculated using a specific formula and indicate how likely you are to pay back a loan on time. But while paying off debt is a good thing, it may lower your credit score if it changes your credit mix, credit utilization or average account age.
With the debt avalanche method, you order your debts by interest rate, with the highest interest rate first. You pay minimum payments on everything while attacking the debt with the highest interest rate. Once that debt is paid off, you move to the one with the next-highest interest rate . . .
Your monthly payments for life, car, renters, homeowners and health insurance may hurt your score if you pay late, but they won't help if you pay on time since they are typically not reported to the credit bureaus.
Paying employees only once a month can lead to more predictability of payroll costs and cash flow. With an entire month to track employees' wages, you have a more accurate date to predict what payroll as a whole might look like the following month.
Your monthly subscription services could serve as a path toward building credit, as long as your payment activity gets reported to the credit bureaus. You can ensure this happens by either paying your subscription with a credit card or signing up for a service that reports your payments to the credit bureaus.