Important Considerations for Paying Off Debts
Consumer debt is on the increase. With tuition rates on a continual increase, student loans are a considerable part of the debt that the younger Gen X, Millennial, and Gen Z populations face. Mortgages, auto loans, and credit card debt round out the types of debt that a majority of Americans will assume throughout their lifetime. While having some debt can boost your credit score, having too much debt can quickly become overwhelming. Here are a few considerations for paying off debt and planning your debt repayment process.
Good Debt vs. Bad Debt
There is such a thing as “good debt,” within the parameters of a budget and the definition is largely situated on the return on the investment versus the cost of obtaining and maintaining the loan. Going into debt for school, obtaining a mortgage, or starting a business are often seen as good debt. Why? Because they are investments that tend to appreciate in value over time. Certainly, there are downsides. Depending on your chosen major in college, there are some areas of study that reap higher income levels (e.g. science, technology, engineering, and math). And not all businesses survive their first five years of operation.
But when compared to things like credit card debt or an automotive loan, attending school, buying a home or kickstarting a new business are appreciative investments. Meanwhile, high interest rates on credit cards (which are higher than mortgages or other forms of collateralized debt) translate into you paying more for consumable items than you would if you’d paid cash.
Should You Pay Debt Off Early?
While paying off debt, in general, is a good move to make, whether you should pay off your debt early depends on several factors:
- Your current financial situation (do you have extra cash left over after paying all of your bills for the month and do you have an emergency fund in place?).
- The interest rates on the various debt.
- Potential tax incentives such as for mortgages and student loans.
- Possible penalties for early debt repayment.
Also, the type of debt often determines the benefits—if there are any—to early repayment. School loans, for example, stick with you regardless of your financial situation. They will not be removed in the event of a bankruptcy. There are various tax credits for continuing to pay off the loan over time. However, these can change depending on decisions made by the current presidential administration and the U.S. Congress. One thing to consider is how that monthly expenditure can be turned into income. Once the school loan is paid off, that same amount can be shuttled into an investment account that earns interest. Therefore, you’ll be earning money rather than losing it.
Auto Loan Debt Repayment
Unless there is a stipulation in the auto loan contract that penalizes you for early repayment, this is one debt that is prime for paying off ahead of time. As much as you may enjoy your vehicle, it is a drain on your income and consistently depreciates over time. While it’s good to keep some debt on your credit record to demonstrate you’re a responsible debtor, that money could be used elsewhere to improve your financial position directly.
Mortgage Loan Debt Repayment
Mortgages have more flexibility in terms of early payment benefits. Although you’re purchasing (or have purchased) a home to live in, homes appreciate in value. So, you’ve already started your investment income by purchasing this type of asset. Should you have extra money on hand, you could also direct it into an investment account and earn interest more quickly than you would by paying off the mortgage. This also depends on whether or not you intend to sell your home at a future time. Though it’s considered to be an investment, it’s not an asset that provides an immediate yield, meaning you have to sell the home in the right market conditions to make a profit.
Credit Card Debt Repayment
Credit cards are an excellent way to build your credit score. But they have high interest rates, and yearly fees offset this benefit over time. Reducing your credit card balances also minimizes your debt to income ratio, which is an important factor for determining your credit score and the possibility of obtaining other loans. Carrying small balances and paying them off quickly is a great way to keep your credit score on the high end. So, paying off credit cards early is most beneficial as it lowers your monthly expenditures while maintaining good credit.
Plan Your Debt Repayment Strategy Today
Always read the fine print of loan contracts and the credit card terms and conditions carefully. Repaying all debt frees up your cash for other things including investments that actually earn you money rather than draining your bank account.
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