Generally speaking, people are less than enthused about being indebted to others. As a result, it is understandable that when people have the means to pay off their outstanding balances, some of them will want to do so earlier than expected. This isn’t necessarily a bad thing, but interested individuals should know that there can be serious downsides to paying off debt early, meaning that they will want to look at both sides of the argument. Here are five examples of when paying off debt early can be considered a mistake:
1. Early Repayment Fees
Lenders make a lot of their money from the interest charged on their loans. As a result, they tend to be less than enthusiastic about early repayment of their loans, which is why some of them have early repayment fees. In extreme cases, it is possible for these early repayment frees to be so high than they can effectively eliminate the financial benefits of paying a debt early. Due to this, interested individuals need to look into early repayment fees and other potential complications so that they can get a clear picture of exactly what they can expect if they follow through their early repayment plans.
2. Other Debts with Higher Interest Rates
It isn’t uncommon for someone to have more than one kind of outstanding balance. For example, a new graduate might have a student loan plus outstanding balances on one or more credit cards. Generally speaking, if someone wants to pay off a debt early, they should do their best to pay off the one with the highest interest rate. After all, focusing on the debt with the highest interest rate means bigger savings that can be put to much better uses elsewhere.
3. You Might Be Cutting Costs Too Much Elsewhere
If people are cutting their costs elsewhere to fund their early repayment, that could do more harm than good. One excellent example is how people should have some kind of fund prepared for emergencies, which serves as a financial cushion. If interested individuals use their money to make early repayments while neglecting to save up for this fund, they could end up regretting it if they run into something serious. Another excellent example is how someone who focuses on early repayment while neglecting their retirement savings could end up regretting it because earlier retirement savings produce much better results in the long run because of the time value of money.
4. Missed Opportunities
Money that is spent on early repayment is money that can’t be used for other purposes. This is something that could cost interested individuals a wide range of missed opportunities because their cash went somewhere else. For example, there are cases when putting money into an investment can earn more for an investor than what they can expect to save by putting that same money into the early repayment of their outstanding balances. As such, when people are thinking about paying off their outstanding balances, they need to examine the financial consequences of their choice before comparing them with the financial consequences of other options in order to build a complete picture of what is happening. Otherwise, they won’t be doing much better than running on gut instinct, which tends to be a less than optimal way of managing their finances.
5. Credit History
Unsurprisingly, outstanding loans have a huge impact on a person’s credit score. For instance, making payments on an outstanding loan shows that said individual has a consistent history of paying their debt, thus making them more attractive as a borrower. Similarly, having a loan in the mix of a person’s credit products shows a more sophisticated understanding of credit as well as the best ways to use it. Unfortunately, someone who chooses to pay off an outstanding balance risks losing out on the positive impact to their credit scores, which can make it more difficult for them to get access to good financial products at good terms than the alternate option. Considering how important such financial products can be, this is much more serious than it might seem on initial consideration.