Category: Tips

Is it Always Wise to Pay a Loan Back Early?

Paying a loan back early is something that can seem really great. You will no longer have that debt hanging over your head, you will have more money available each month as you will not have the repayments to make and you could potentially save a lot of money. However, there can be disadvantages to paying back some loans early and it is therefore looking at the pros and cons before making up your mind.

Some loans will have an early redemption fee. This means that there will be a charge associated with paying it back early. Sometimes it may just be a month’s interest, or a small lump sum to cover the admin costs. However, it can be a significant amount of money. It is therefore always worth finding out from your lender what the fees will be and then working out if it will be cheaper to pay the loan off early. The fees may be more expensive if it is a bigger loan, but then the total interest payments will be as well.

Some people do get concerned that if they use their savings to pay off a loan then they will be foolish. They worry what might happen if they need money and they do not have any. However, it is worth looking at things with regards to the cost. If you keep money in a savings account then you may get a small amount of interest. It is highly likely that you will pay more money in interest on a loan. Therefore it would make sense to use the savings instead of borrowing money or use them so that you can borrow less. If you do need money in the future but have no savings, you could always borrow more, but this may not be very likely, particularly if you are careful. In the meantime you can take advantage of having no loan or borrowing less and the huge amount of money that will help you to save.

There are some loans though, which are better not to pay off early, but they are rare. One example of this is a UK student loan. At the moment these are paid back over 30 years, but repayments are based on earnings and so if you do not earn very much, you will not have to make any repayments. Paying this loan back early is often seen as inadvisable. This is because many people will not pay back the full loan in the term. Once the thirty years is up the loan is written off. This means that even if the full amount has not been paid back, it is gone. It can be hard to now what you will be doing in the future and whether you will always be working and always earning enough to pay back the loan. However, if you are likely to take time off work to have children, perhaps work part time to look after you family or work in a field where there is a risk of you losing your job, then you could find that it is better to not pay it off as you could end up paying back a lot more than you need to.

It can also be cheaper not to pay off a loan in a few rare cases. An example would be when someone has an interest only mortgage and the money that they are saving up to pay it off is invested well. This investment could potentially make a lot more money than would be saved by not paying the interest payments on the mortgage. Specifically if interest rates were low and investment returns high then it would be more advantageous financially not to pay off the loan early.

However, most loans do not work like this. Most loans have to be paid back in full, sometimes over a specific term and sometimes it is possible to decide yourself when to pay it back. Paying back as quickly as possible means that the loan will be cheaper and so it means that you will potentially save a lot of money. This is why many people feel that it is the best option in most cases.