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Pay off a loan early - Should you do it?
There are some benefits to paying off a loan early
During the course of our lifetime, the average American will borrow money many times from a variety of sources. While most loans, such as mortgages, take a long time to pay off, it is occasionally possible to pay a loan off early. But should you?
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Early loan repayment has its good and bad points
The cost of living in modern society is such that hardly anyone can afford to pay cash for everything anymore. Today, life is all about loans - home loans, auto loans, credit card and tuition payments, and so on. For many people, these monthly obligations become crushing debts that make it impossible to put even a dollar in savings. But other people sometimes find themselves in a position where it might be possible to pay off a loan early. But should you?
There are good points and bad points to paying off a loan early. Here are some types of loans and some notes on whether or not it might be worthwhile to pay them off early:
- Mortgage - The home loan is the single biggest financial obligation that most people hold; it usually takes 25-30 years to retire a mortgage. On the other hand, interest rates on mortgages tend to be quite favorable when compared to other types of lending, such as from a credit card. Unless your loan is at a high interest rate, you probably won’t benefit too much from paying the loan off early. You do get a mortgage interest deduction on your Federal income tax, which effectively reduces the interest rate. There is benefit, however, to adding extra payments to the principal if you do it early in the life of the mortgage. If you do want to pay off your loan early, watch out for an early payment penalty.
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- Home equity loan or line of credit - Interest rates on home equity loans are higher than for first mortgages, so you might wish to pay these off if you can. With a line of credit, you can borrow again after you repay, so there might be some benefit to that if you tend to use the account over and over.
- Credit card loans - Unless you have a temporary, “teaser” interest rate of 0%, there is no reason to keep a credit card loan any longer than necessary. With interest rates that run as high as 30%, it can be very expensive to borrow against a credit card. Pay it off as soon as possible.
- Student loans - These financial arrangements have the lowest interest rates you will ever find. There is no benefit in paying interest if you don’t have to, but if you have any better place to put your money, put it there first. Use the money for high-yield investments or use it to pay off any credit card debts you might have before paying off student loans.
- Auto loan - It’s generally a good idea to pay off an auto loan as soon as you can, but if you have a promotional interest rate of 0% or 2%, you might wish to look at paying off other bills first.
When looking to pay off loans, you should always look at those with the highest interest rates first. Those are the ones that take up the most of your money. Pay them first and work your way down to those with the lowest rates.
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