Why Pay Off Debts Early?
When you have disposable income, paying off debt early is a no-brainer. For many Australians, a home loan mortgage is the most significant debt that they take on. So wanting to pay off your mortgage as early as possible is a given. Being debt-free not only has psychological benefits but measurable financial benefits as well. Sounds pretty good, right?
Well, paying off a mortgage early isn’t always the optimal strategy as it is laid out to be. Usually, the incentive for paying off debt early is that you’ll save money, but there may be some significant benefits to keeping the loan in place. There is no right or wrong answer here. So if you want to pay off loans early, here’s what you need to consider.
Benefits of Paying Off Debts Early
The biggest reason to pay off debt early is to save money and stop paying interest. Interest charges are the amount you pay in exchange for time. You are paying for the flexibility of spreading your payments over several years instead of paying for the home in full right now. There is no other favorable outcome of paying interest. Most mortgages have a 30-year loan term, and interest charges add up over time, while loans with shorter terms have higher interest rates making them even costlier. Therefore, with terms like these, it is wise not to extend the time and pay off debt as soon as possible.
Strengthen Financial Standing
Once you’ve paid off your debt, your financial standing will be stronger. The amount you were expending on monthly payments will now be available for use for other purposes. Thus, your desirability as a borrower also increases. Lenders like to see that you have sufficient income to repay loans, and they assess this by calculating your debt-to-income ratio. The debt-to-income ratio (DTI) represents the percentage of your income that goes towards paying debts. If you pay off debts early, your DTI improves, and you will have a higher chance of getting approved for a new loan under favorable conditions.
Paying off your debts early can also improve your credit scores. How much you are currently borrowing also factors in when evaluating credit score in addition to the maximum sum that you potentially could borrow. If you borrow too much at present, your credit scores will suffer but paying down your loans frees up your borrowing capacity.
Peace of Mind
Having too many financial obligations, more than you can tend to, can take a toll on your peace of mind. Financial stress is not easy to deal with. So some people choose to eliminate debts as soon as possible despite it not making the best financial sense. As long as you are cognizant of why and what you are doing, you can take any decision that suits your needs. Perhaps you are tired of making monthly payments, or you want to decrease the number of debts before retiring, or you don’t like the notion of paying interest to the lenders. Whatever the reason is, you must always evaluate the benefits and drawbacks of keeping a debt thoroughly to make an informed decision that you can live with.
Drawbacks of Paying Off Debt Early
If you want to pay off debt early, a large part of your income goes towards debt payment. So, you will have to minimize your monthly expenses such as groceries, utilities, etc., or you will have smaller emergency funds for you to fall back on, making you more vulnerable to an unforeseen financial crisis. Moreover, you won’t have the finances to invest if the opportunity arises, as you’ll be strapped in cash due to higher debt payments.
As with many things related to home loans, it comes down to you to decide whether your money is better spent paying off debts or investing in other ventures. If you could earn more on investments than you would have saved in interest, it is wiser to invest rather than paying off your debts early. However, it is rarely this straightforward. Sometimes, lenders may charge you for paying off your loan early, also known as prepayment penalty fees. While prepayment penalty fees are quite frequent with mortgages, they can vary depending on the type of loan you have. So, knowing the terms of your loan is crucial before you pay it off.
Need more financial advice? Contact our Nepali mortgage brokers to discuss your situation and receive the best financial advice tailored to your needs.