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Tip #21: Save thousands by pre-paying your debt

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This is Tip #21 of of the Save $1,000 in 30 Days Challenge. (See past tips.)

Today’s tip is to save money on interest payments by paying a little extra off your loan each month. Because loans are usually large amounts spread out over many years, the savings can be significant. The longer the loan, the more you save.

pay-off-debt-over-long-term.jpg

Let’s say you have a $10,000 student loan, at a 6.8% interest rate and a 10-year repayment period. If you go with the standard monthly payment you’ll pay around $115 a month. But look at how much you’ll save in interest if you just pay $100 more each month:

Monthly payments         Total interest paid             You save
$115                                         $3,810                                         $0
$215                                         $1,640                                         $2,169
$315                                         $1,056                                         $2,754
$415                                         $782                                            $3,027

accelerate-debt-payments.png

Remember, even $20 more per month can save you SIGNIFICANT amounts of money. Note: Earlier I wrote “You have $100 extra per month. Should you pay off your mortgage early or invest?” and linked to two great articles. The point is, if can contribute even a small amount per month — whether to investments or any loans — the benefits can be huge.

See for yourself: Calculate your own savings using this calculator.

Total saved: $0 to $200 per month

* * *

Last thing to do
1. See other tips in the Save $1,000 in 30 Days Challenge
2. Leave a comment on this post describing how much you’re saving with this tip and any unusual techniques you use to make this tip work.

If you liked this tip, check out my Premium tips — one long, tactical tip per week. Save money or get a 100% refund.

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44 Comments on "Tip #21: Save thousands by pre-paying your debt"

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Todd
7 years 7 months ago

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.

Teaspoon
Teaspoon
7 years 7 months ago

So, this is a very basic question but one that I haven’t really been able to figure out. My husband and I have a decent emergency fund that we’re comfortable with for now. We also have $20,000 in student loans (6.25% interest) and have just opened Roth IRAs. Should we concentrate on maxing out our Roths each year, or work on paying down that student loan? Right now, we can’t afford to do both, although in a few years (hubby’s in grad school right now) we should be able to.

Jorge
7 years 7 months ago

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

Alan
7 years 7 months ago
Yes, it may be attractive to put that extra money each month towards paying off student loan debt, but doesn’t investing that money in the market make more financial sense? Student loan interest rates are generally much lower (4-6%) than the historical ROI one would get by investing into an index fund (8-11%). The interest that accumulates with student loans may seem daunting (trust me, 60K in debt and I know!), but overall one would still get a higher return by investing extra income into the market. What’s the balance between this idea and trying to pay one’s loans off… Read more »
Beth
Beth
7 years 7 months ago

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.

Trevor
7 years 7 months ago

I never knew about this because I haven’t been in debt yet.

Nice visuals, definitely something I need to look at.

Jeff
Jeff
7 years 7 months ago
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… Read more »
trek
trek
7 years 7 months ago
We have paid on the back end of our mortgage since its inception. We also refied to the tune of a 3-3/8% savings. Instead of paying the bank back for 30 years, we are looking to be out in 12. Money saving tip for eating out: Don’t automatically order a kid a kid’s meal… We took our six year old out for Mexican a couple of weeks ago. The kids’ menu prices were $7-9 each, which included rice and beans, soda, and dessert. We don’t let the child rink soda, she doesn’t like rice and beans, and there was grocery… Read more »
Dana
Dana
7 years 7 months ago
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… Read more »
Ashley
Ashley
7 years 7 months ago

I know it sounds silly, but for the debt I am trying to get rid of, I pay on it 2 times or more per month, when I get paid. I break the payment in half and usually add more to it if able. This keeps the interest I pay lower because it is only accruing for a week or two, and helps me to see faster progress on getting these paid off!

Susan
Susan
7 years 7 months ago
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… Read more »
Peggy
Peggy
7 years 7 months ago

I have $0 to invest, but I do like Ashley and pay my mortgage twice a month. I also round it up, so instead of paying $1230 once a month I’m paying $650 twice a month. I don’t expect that $70 to get me financial security in the short term, but it’s a $70 I can sneak out of the budget without hurting us too badly.

This tip: According to the provided calculator, I’m saving $61.20 a month over the length of the 30 year loan by spending $70 a month extra. Hm. Maybe I need to rethink this.

Cumulative total: $90.75

Rae
Rae
7 years 7 months ago
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… Read more »
Hans
Hans
7 years 7 months ago

I am so tired of hearing “historicaly the stock market has outperformed … blah, blah, blah”. Last year my personal banker was trying every line in the book to get the $100,000 in my saving account, making 3%, into their mutual fund set-up. Well gee, I guess I can laugh with my 100k+. Personal responsibility will always outperform the market.

pickeju
pickeju
7 years 7 months ago
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… Read more »
Stop Getting Cheated
7 years 7 months ago
I used this strategy on my mortgage, Ramit. It paid off extremely well. I have a friend who is retiring in 15 more months. She has been adding $400 to her mortgage payment each month for past six years. She’ll have her house paid for when she leaves. If you are disciplined enough to do this, it will save you a ton of money. I had another friend who wanted to break her payments in half each month, but the mortgage company wanted to charge her close to $300 just to set up the program. Unbelievable. It is easier just… Read more »
Keeley
7 years 7 months ago

YES! Awesome tip. =)

Michael
Michael
7 years 7 months ago

I do think that the example of paying down a student loan is not a good one. Student loans are about the best kind of debt you can have. First off, the interest rates are insanely low compared to most other loans. Second, you can directly receive credit, dollar for dollar, of all interest paid in a year off of your income taxes via a tax credit.

While pre-paying most debts would be prudent, I believe you should just stick to your monthly student loan payments and reap the sweet tax benefits.

Susan
Susan
7 years 7 months ago
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… Read more »
Thisson
Thisson
7 years 7 months ago

I think it’s foolish to deliberately keep debt outstanding (e.g. student loans) to “invest” the balance in the market.

Just pay off all your debts first, and then invest. Don’t try to take shortcuts — you could get burned. If your investment in the market turns south, you just dig a deeper hole for yourself.

If you live within your means, everything else will sort itself out.

atomiclightbulb
atomiclightbulb
7 years 7 months ago
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… Read more »
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[…] Tip #21: Save thousands by pre-paying your debt […]

Darla
Darla
7 years 7 months ago
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… Read more »
Rae
Rae
7 years 7 months ago
Thank you Susan for the sound advice. I think we will follow it, using half the bonus to pay down the car debt. btw, we bought the car used last year, so a large percentage of our payments is still going to interest. We have no other debts except for student loans (which now, after reading this tip, we’ll try to prepay a little each month), and while we do have a substantial emergency fund, we haven’t yet opened up retirement accounts, although we plan to do so before the end of the year. This is probably Ramit’s best and… Read more »
Mark
Mark
7 years 7 months ago

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.

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[…] I Will Teach You to Be Rich presents Tip #21: Save thousands by pre-paying your debt. […]

DebtGoal
7 years 7 months ago
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.… Read more »
Kat
Kat
7 years 7 months ago
For those people with PRIVATE student loans, your interest rate isn’t fixed. Right now my highest interest rate is 6.25%, but in the past 4 years, it has been as high as 12%! I have excellant credit, too. I know people paying as much as 20% for their PRIVATE student loans. My federal loans are less than 3% because I fixed the interest rate and have on time payments which gets me a break. I know people with federal loans at 6% fixed though. As for the tax credits, it isn’t worth it. I pay more in interest than the… Read more »
RK
7 years 7 months ago
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… Read more »
sotuhcampus
sotuhcampus
7 years 7 months ago

I believe in the philosophy, Cash is King. ( Dave Ramsey)
I have a mortgage, student debts and 401K
plan on paying the home off first, investing in Roth every year and then tackle the student loans.
cannot wait until it is all behind me, let the journey begin

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[…] 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… Read more »
Debbie
Debbie
7 years 6 months ago
When I bought my last house I was just out of college and had a great paying job. Real estate agents were trying to sell me on houses that would max out my budget and I didn’t need all that extra space (you have to C L E A N it!). I bought a modest but nice home in a great established neighborhood and all the extra cash I saved by not buying the expensive house I used to pay down the principle. I had a 30 year mortgage paid off in 9 years! That was great because due to… Read more »
Manda B
Manda B
7 years 6 months ago

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?

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[…] You can also get huge advantages by pre-paying your debt. […]

Barbara Saunders
Barbara Saunders
7 years 6 months ago

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.

trackback
7 years 4 months ago

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

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7 years 3 months ago

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

Alandra
Alandra
7 years 3 months ago

For all the posters talking about low student loan interest rates, the Federal Stafford loan rates system was recently changed. For the past few years, rates are fixed at 6.8% (the number used in the article) and can not be consolidated to a lower rate as was the case in previous years.

They are going back down, but since I’m graduating this year, it’s no help to me.

trackback
7 years 1 month ago

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

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7 years 23 days ago

[…] 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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[…] 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 […]

GlassesShop
3 months 3 days ago

This is a great tip, interesting post

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