When paying off debt early is a bad idea

When paying off debt early is a bad idea

Living a debt free life sometimes feels like a fantasy, an ideal life that anyone would want to achieve.

So paying off debt as early as humanly possible seems like it makes sense right?
The hard truth is that it’s not that simple.

Here are a number of scenarios when paying off debt early doesn’t make sense:

Scenario 1: Savings, what savings?

If you don’t have any savings, paying down debt prematurely should probably not be your first priority.

Savings are your cushion against the unexpected challenges in life.

What would happen if you lost your job tomorrow or if you fell ill? Do you have savings to help you deal with that?

If you lost your job tomorrow, you’re likely to be more concerned with your next meal than your zero income to debt ratio.

Similarly if you fell ill, the zero debt is unlikely to buy you medicine.

Bottom line:  Work on your savings to debt payoff ratio.  Get a good little nest egg, and then think about paying off your debt prematurely

Scenario 2: Is there a penalty for premature settlement of debt?

Sometimes, paying off debt early, can incur a penalty from your financing company!

Financing companies make money from interest. That is their main revenue generator, so sometimes in an effort to protect their revenue, they include a deterrent from early repayment!

If you have such an agreement, it might be best to consider the cost benefit analysis of paying off your debt prematurely vs the interest that incurred.

Bottom line: Read your contract to make sure you understand the costs vs the benefits of early payoff.

Scenario 3: Could your money earn you more money than you pay in interest?

Is it possible that you can invest your money in an activity or savings accounts that would allow you to earn more than the interest on your account?

A very simple example.

If you are given the opportunity to place your money in an investment vehicle that earned you 8% compound interest vs paying off a loan that cost you 4 % compound interest.

It may be wise to reconsider paying off the debt prematurely.

Bottom line: By paying off the debt prematurely you could be sacrificing the opportunity to make money.

The Bigger Picture

Debt can be troublesome for many of us. If your level of debt is at a level you are uncomfortable with consider refinancing your debt to a lower interest rate.

Or alternatively making the determination that sometimes your peace of mind may be worth sacrificing the benefits mentioned above.

Financial security is never a one size fits all situation.
Kim Roberts

Kim Roberts is an accounting professional, currently in the field of international development finance. She is a makeup lover, ACCA qualified and committed to all things Caribbean especially Soca music. You can find out more about her love of makeup at http://bajanbeautyblogger.com/ where combines her love of makeup with a need to write opinion based pieces.

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