Todd

This is a great tip. What makes it so great? Paying down debt is a guaranteed return on your money. The rate of return is the interest rate of your loan. It is hard to find many guaranteed returns on your money. Generally speaking, if you have a solid emergency fund then paying down debt can be a very smart next step particularly if it’s high interest debt.

Jorge

This is a great tip, particularly if you apply it to a big loan like a mortgage. Over 10 or 20 years the savings are astronomical.

Also, if you look at the alternative, investing in the stock market, it’s nice to know you’ll be getting a safe (if low) rate of return on this investment.

-Jorge @ IndependentMinded.org

Beth

Interesting post I like the visuals. The example is actually quite close to the my own situation (student loan is my only debt). I was recently able to free up some extra cash, so I had to think long and hard what to do with it. I ended up deciding to invest it instead of put it off on my loan. It’s for my retirement — and I figure every little bit helps. I’m hoping the strategy will pay off in the next thirty years.

Jeff

I have been doing this for some time now. When I bought my house, my lawyer who was with me for the closing explained this to me and gave me a website with a mortgage calculator. I am paying enough extra each month to equal 2 complete extra payments per year, and it is going to cut 9 years and almost 130k off my total interest payed over the course of the mortgage. If you have the extra income, I would suggest doing this.

My lawyer said what a lot of people try to do is make a half payment every two week. This allows you to make 26 half payments, or 13 full payments. That is an extra payment per year, and can save you a ton on a 30 year mortgage.

Dana

I was just debating last night what I would put this year’s tax return toward. I have three big “items” right now. 1) My student loans, 2) mortgage, and 3) my son’s (almost 11) college fund. The more I think about it and the state of the market I think if I have the chance to pay off a huge chunk of something, I am better off paying down the student loans because the sooner I pay that off, the sooner I will have that monthly payment back in my pocket and maybe by then it will be worth the risk of investing it for college. (Of course, I already pay a little extra each month toward my mortgage principal, and I try to re-examine that amount and increase it when I can.)

Susan

Hey, didn’t I send you this tip?
In response to Todd – the rate of return on paying down debt is actually higher than the interest rate on the debt. Why? Because you’re paying interest with after-tax earnings. For example, if you are in the 25% tax bracket, you’ll have to earn $100 to pay $75 of interest charges.
Conversely, for those who are inclined to invest rather than pay down debt aggressively, your rate of return on investment is frequently reduced by taxes. The exception is tax-deferred contributions to retirement plans – and even those contributions will eventually be taxed upon withdrawal. The most commonly cited form of “good” debt is the home mortgage – just think of the tax benefits!! – but the reality is that, depending on your tax bracket, you are paying $1 of interest to gain 20-35 cents of tax benefits.
That said, my husband and I are currently carrying a mortgage because, like most people, we didn’t have the cash to purchase a home. BUT, I’m in the process of refinancing from a 30-year term to a 15-year term, which will save nearly $100,000 over the course of the loan. If interest rates hadn’t declined significantly since we took out the loan, we would simply pay a little more on the principal each month rather than go to the expense of refinancing.

Rae

If anyone can answer this debt pre-payment question I’ve been grappling with recently, I’d be very grateful.
My husband is anticipating a $10,000 end of the year bonus, which we are trying to decide how to use. It is very tempting for us to use the bonus to pay off our car loan outright (we have a 2003 Civic). We would like to save on the interest, but are concerned that it would be risky to tie up more money than necessary in a value that can be damaged or destroyed so easily. Does anyone have any thoughts or answers about the wisdom of using this lump sum to pre-pay a car loan?

pickeju

This is really a necessary component of working your way out of debt, but it’s important to note that it’s usually best to chose one debt at a time to pre-pay. Paying a little extra on several debts with various interest rates will help you, but targeting any extra debt payments toward one goal at a time seems to be a more aggressive, worthwhile approach. This works especially well if you can wait out the first debt completely until it’s paid, and then snowball ALL of that payment to the next debt.

It’s a little easier to wrap your head around and see the benefits, as well. I was prepaying a little bit on 3 or 4 different debts, but it was hard to see the progress. Snowballing does take patience until you get the first debt paid off though, so start with something easy and with a shorter-term.

Keeley

YES! Awesome tip. =)

Susan

Rae, I posted a comment above but I want to address your question. The answer is, it depends. Did you buy the Civic new in 2003, bringing you very close to the end of your loan? If so, you’re paying very little interest each month due to amortization – you’re now knocking out the principal balance very quickly. Or did you buy the Civic used more recently, meaning that you haven’t paid the loan down much at all and that a large component of each car payment right now is interest?
Do you have other debts? Any money set aside for unexpected expenses?
My first inclination would be to put about half of the bonus towards the car debt and bank the rest in a rainy-day fund.
As far as the value of the car being easily damaged, that’s why you have auto insurance.
If you do put the entire bonus towards your car debt, set up an automatic deposit into a savings account equal to the amount of your current car payment, once the car is paid off. You’re used to making the payment anyway – just pay it to yourself and create a fund for your next car.

atomiclightbulb

I disagree with Michael. Student loans are the one of the WORST kinds of debt you can have. They don’t necessarily have low interest rates, especially when it comes to private loans that were given out when interest rates were higher.

Student loans cannot be discharged in bankruptcy.

Student loan companies have extraordinary powers to collect on their loans and extract fees and penalties from their victims. They can garnish your wages, take your federal tax refunds, and even snatch your Social Security payments when you are old and unable to work. In short, they can destroy your life and render you a penniless wage slave if you fall behind on your payments. Scammie Mae might not be able to break your legs to collect, but she can surely murder you virtually by destroying your credit score and sucking the life out of your cash flow.

Pre-paying student loans is a GOOD idea in many cases. Don’t let these corporate suits and their government lap dogs in Congress keep a hold on you.

Darla

I think it is much wiser to pay off all of your debt as quickly as possible. I know that my 401k took a hit when the market fell like everyone else’s did but if I had a house (which I don’t at this time) whatever money I would have paid down on my house following this tip would have not been lost. Sure, the housing market was hit so it might have effected my house value but we all know that housing values rise so it wouldn’t be long before it was back to it’s original value BEFORE the fall and probably even exceed it in a few years. Also, we all presume that we will live forever and completely healthy to boot. I would much rather have no debt including a fully paid off house for my loved ones when I die especially if it’s unexpectedly then to have a portfolio that’s taken a hit from the recession and will take an even bigger hit from taxes (401K or IRA) when they cash it in to pay off all my debts. I want that to be one less thing for them to worry about. Especially if I became disabled and was no longer able to work. I do NOT want to depend on the government to support me since we all know how well they can balance their own budget.

Mark

I don’t know what kind of student loans you guys have, but the ones I have are fixed at under 3%, so basically a little higher than inflation, we get a tax deduction on the interest, and paying them off faster means losing the time opportunity to have cash compounding in other investments.

DebtGoal

Prepaying debt can clearly pay off in interest saved, especially with high-interest consumer debt. With mortgage or student loan debt, the situation is not so clear and many make a compelling argument that you should never prepay the debt and simply invest the money at a presumably higher return. Notwithstanding the current market performance, there may be merit to this. But many people choose to pay off these low-interest debts anyway. Why? Because paying off a liability makes them feel more secure and this psychic reward actually has a higher return to them than the potentially higher returns in investing. So when considering how to manage your debt, listen to your heart and risk profile in deciding where to put your money. You may find that you put a high value on the security that comes with knowing that you’re making progress on your debts and this just adds to your total return.

RK

Just wanted to mention a small tidbit that readers should find helpful:

For those of us with Stafford Federal Education loans, the government recently has been giving discounts on the interest rate and reducing the interest rate for people who have been on time or making payments well in advance of their due date. One of my loans (which I did not consolidate with my others because I did not want to mess up my 2.8% interest rate) recently went from being $80 to $60 or so per month. Total yearly savings of $240. It’s not much but it’s a start.

ALSO – if you sign up for automatic withdrawals with the feds, you get an additional .5% to .25% discount on your interest rate.

Review: The Save $1000 in 30 Days Challenge | The Thrifty Life

[...] Tip #23: Go cash only for 15 to 30 days – Limit yourself to cash only purchases for two weeks, a month or more. If you can cut out credit card purchases you are guaranteed to save yourself money. How often do you wait for a sale to buy something, only to put it on a credit card that has a higher interest rate than the percent off you saved on the sale? I’m getting into the habit of asking myself – “Is it worth paying 10%(or more) interest on this purchase?” Most of the time it’s not. The other aspect of going cash only is that it forces you to only work with the money you have right now. Try this – it may change your perspective on spending – it did for me. [...]

Manda B

Hey there. Just couldn’t help but notice this strange sentence fragment right after the first paragraph and before the coin picture:

“I took apples to work, helping me to eat healthier and”

What gives?

Barbara Saunders

Caveat on that, though. It makes no sense for a person to throw $100 towards a student loan fixed at 3% only to end up 12 months later laid off, borrowing money from a credit card to pay rent while also putting the loan in forbearance.

March 2009: Progress Update

[...] like to pay off my car loan by March 31, 2009. Goal [...]

May 2009: Progress Update

[...] We would like to pay off my car loan by March 31, 2009. Goal [...]

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[...] Save thousands by pre-paying your debt: For those with a large amount of debt, these tips from I Will Teach You to Be Rich can help you get it paid off sooner. [...]

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[...] Money, Eat Well and Look Hot in Less Than an Hour Tip #20: Change the date of Christmas Tip #21: Save thousands by pre-paying your debt Tip #22: Analyze your progress in the 30 Day Challenge (plus, see how I’m doing) Tip #23: Go cash [...]