What happens when you pay off a loan early?

Living with debt is an expensive and super stressful experience. Though the road may seem long, paying off debts and loans will strengthen your financial future. Nearly every type of loan can be paid off early and there are a few different ways to go about it, according to www.advantageccs.org.

You may choose to make larger monthly payments, multiple payments each billing cycle, or – if available – you may even choose to pay off your loan in one lump sum right then and there.

Each of these strategies will, of course, do the job of paying off a loan but you should read the fine print before you decide because some debts may have a pre-payment penalty.

Paying off a debt early may appear to be an easy decision to make. After all, avoiding additional accrual of interest would seem to save money in the long run. However, there are a number of factors that should be taken into consideration before requesting a payoff quote from a lender.

We’re going to take a closer look at what it takes to pay off a loan and if there are any drawbacks to consider first.

Tax implications

Some loans have tax advantages that would be lost if they were to be paid off early. The interest paid on these loans may be tax deductible and the borrower should talk to their tax adviser about what the tax implications would be before paying off these types of loans. If the tax savings were to outweigh the amount that would be saved on interest, it may not be advantageous to pay these loans off at this time. You have to weigh the pros and cons.

Interest rates

The interest rate is also something to take into account. Credit cards tend to have much higher interest rates than other types of loans, so they should be paid off as soon as possible. If you have multiple credit cards, start with the credit card that has the highest interest rate first and then move on to the credit card with the next highest interest rate.

Continue this process until all credit card balances have been paid in full. Loans with lower interest rates such as mortgages and car loans might not be as much of a priority and any extra available money may be better used elsewhere. Don’t forget to pay those loans on time because they are still really important, but perhaps any leftover money would be better spent going towards paying off credit card debt or medical bills.

Penalties

Another very important consideration to make is whether there is a penalty that would be applied if a loan were to be paid off early. You would need to either review the documentation that you’ve signed when taking out the loan or call the lender to see if penalties would apply.

Depending on the dollar amount of any penalties, the savings in accrued interest may not be beneficial in the end. Sometimes these loans can have very steep early payoff penalties added on.

You have to read the fine print or contact the lender and ask them specifically about any penalties or added fees if you were to pay off the loan now instead of waiting.

Savings

Remember, before deciding to pay off a loan, make sure to factor in the amount that the borrower has in terms of personal savings. The first priority would be to make sure that enough is saved for emergencies. Six to eight months worth of salary should be the goal. This would cover daily expenses in the event of losing one’s job if the borrower or a family member becomes ill or any number of other emergencies were to happen. If an emergency were to occur, it’s much better to have this money available than to need to rely on high-interest credit cards to get by.

Also, if the borrower has children, they may want to determine if their money would be better off being put toward saving for school

Retirement savings are also important and should be a priority. If the borrower’s employer offers a plan with matching contributions, make sure that they are contributing the maximum amount to take advantage of the company match. With fewer employers offering pensions, it is becoming more important that individuals make sure that they have enough saved for a secure retirement. Once all of these factors have been taken into consideration, you will be in a better position to determine whether it would be in your best interest to contact your lenders and request a payoff amount.

Auto loans

Auto loans are something that some are faced with at some point in their lives, and like all loans and debts, the interest accrued each month can really add up. By paying off the loan in its entirety, or even by increasing your monthly payments, that interest will no longer accrue. By eliminating your car loan debt, not only will your credit score improve, but you will have more money in your pocket each month to put towards savings or toward any other debt you may be dealing with. However, sometimes paying off an auto loan early won’t save you anything.

Personal loans

It’s also a good idea to consider paying off personal loans early, if possible. Not all personal loans can be paid off early, depending on the terms of the loan. If, however, it is a possibility, start putting extra money toward that debt to bring it down and pay it off. Just like any other debt repayment, your credit score will improve, you will have more cash on hand each month, and you will be more likely to be approved for loans in the future, and under more desirable terms.

Potential drawbacks

Although there are many benefits to paying off a loan early, there are potential drawbacks as well. Say you have a lump sum that you would like to use to eliminate a loan that is hanging over your head. Yes, if you pay it off, the loan will be gone – but so will all of the cash you put towards eliminating it. Once that money is gone, you cannot get it back, no matter how badly you may need it. And in today’s unstable economy, it is wise to have money set aside as an emergency fund in the event of an unexpected event such as illness or job loss. It is important to remember that in the unfortunate event you do become unemployed; you will not have the income necessary to qualify for a loan no matter how badly you may need it. It becomes a vicious cycle: it becomes harder to get cash when you end up needing it the most.

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