Published in: Credit Cards | Sept. 25, 2019

Why Some Debts Just Shouldn't Be Paid Back Early

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Paying off debt is a common financial goal, but does it always make sense to pay off what you owe ahead of schedule? 

If you're in debt, chances are good that paying off your balances is one of your financial goals. After all, debt costs you money and interferes with your ability to do other, better things than sending interest payments to creditors.

But while there are some debts that are damaging to your finances and should be paid off as soon as possible, there are other situations where paying creditors back ahead of schedule isn't really a wise financial move. Here's why.

Man running through door from a whirlwind of papers.

Image source: Getty Images

Why you shouldn't pay off certain debts early 

There are two particular types of common debt that typically should be paid back slowly over time: mortgage loans and federal student loans.

Paying off these types of loans early doesn't make sense for a few key reasons:

  • These debts typically have very low interest rates: The interest rates on both mortgages and student loans are usually well below the rate of return you could reasonably expect to earn if you invest your money in a diversified mix of safe stocks on the stock market. It makes little sense to pay off a loan that charges 3% to 5% interest when you could likely earn 7% or 8% returns by instead taking on minimal risk and investing your money in ETFs that track the market's performance. 
  • Debts can be tax deductible: Interest paid on mortgage debt is tax deductible on mortgages up to $750,000 or on loans up to $1 million if you borrowed before December 2017. You do have to itemize to claim this deduction. There's also a student loan interest deduction that allows you to deduct up to $2,500 in interest paid on student loans. While you don't have to itemize, your income does have to be below a certain threshold to qualify for the deduction (eligibility begins to phase out at $135,000 for married filing jointly and $65,000 for other tax filers). These deductions further reduce the costs of paying back these debts. 

For federal student loans, there are also other reasons it makes little sense to pay back the debt ahead of schedule. 

These loans come with tons of flexibility in how you repay them. You can put loans into deferment or forbearance and pause payments, and you can change your payment plan to a number of different options -- including plans that cap payments as a percentage of income. Loans can also be forgiven after a certain number of years of paying on an income-driven plan or making payments while doing qualifying public service work. 

Always consider opportunity cost

When deciding whether or not you should pay back debts ahead of schedule, it's always important to consider opportunity cost. Any extra money that you put towards debt -- above making minimum payments -- is money you could have used for investing or for other purposes. 

If you have higher interest debt, such as credit card debt this should be paid back ASAP. This is because the return on investment -- the interest you save -- will likely be a better return than you could get from investing or other things. 

But if your interest is low, you can reduce your taxable income because of the interest you pay, and you can do better things with your cash, debt repayment may not actually be the best financial goal for you. 

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