In our daily lives, we struggle to balance our jobs, families, social activities...the list goes on. Juggling different forms of debt is no different. Like any part of life, dealing with your debt is all about setting priorities.
You may want to pay off your debt as soon as you can and set your mind at ease - but wait! Although debt is generally thought of as a bad thing, a reasonable amount of debt can actually be good for your credit health if you manage it well. Making timely payments on your loans shows lenders that you're a reliable borrower who is likely to pay back debts in the future.
So, think twice about paying off any of your debt early. It may be right for you, but it may also backfire. Let's talk about both scenarios.
How can you benefit from paying off your debt early?
- Less debt means you have a more flexible cash flow. You will have more money at your disposal to spend on the big picture, like setting up an emergency fund and maxing out your retirement accounts. Breathe easier and live a little.
- Paying your debt off early lowers your debt-to-income ratio and credit card utilization. Lowering your credit card utilization could improve your credit health since the recommended usage is 30% of your total credit limit. If you want to apply for a new credit card or loan, having fewer payments on your back could also make you less of a risk in a lender's eyes.
What are the downsides to paying off your debt early?
- Some contracts have prepayment penalties baked into them. Since lenders benefit from the interest you pay on a loan, they don't want you to pay debt off early. Review your contract or check with your lender before getting hit with a hefty fee for being proactive.
- Your credit score may be affected if you pay off an account and it's reported as closed. Having multiple open forms of debt diversifies the types of accounts you have and lengthens the average age of your credit history.
- You lose out on tax benefits. The interest you pay on your student loans and mortgages is tax deductible. This is a key reason why some people jump into the housing market.
Of course, paying your debt period is another story. Why should you always pay on time?
- Not paying your mortgage could cause you to lose your home, and missing your monthly auto loan bills could result in your car disappearing before your very eyes. Say goodbye to a roof over your head and the open road.
- Unlike credit cards, student loans can't be forgiven or discharged through bankruptcy, so if you fail to pay these off they will remain on your record forever.
- If you're 30 days late on any payments, your lender could report the account as delinquent to the credit bureaus. The debt could also be sold to collections agencies.
It pays to pay on-time.
It's probably a good idea to pay at least the minimum balance requirement and definitely to pay on-time. Being late on any payments will impact your credit and could cause you to lose your home or car. Whether you should pay off your debt early is another story. Weigh the pros and cons and take control of your debt.
About the Author: Charmaine Ng is the Communications Coordinator at Credit Karma. When she isn't writing her way through life, you can find her reading about the latest in entertainment and watching television almost every night of the week. Say "hi" @noodlemaine!
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