The Pros and Cons of Paying Off a 0% Interest Loan Early
Sometimes, we get lucky and are offered a 0% interest rate promo for a specific term. This rate is frequently seen with auto loans, mattress stores, furniture stores, and for credit card promotions. For these big-ticket items, paying no interest could mean a massive savings on each payment.
For loans that have an interest rate above 0%, paying them off early (provided there are no pre-payment fees) is a no-brainer: you’re saving money on interest payments and contributing more to the principal each month.
However, should you ever pay off a 0% interest loan early? Assuming you are capable of paying the balance before deferred interest sets in, why pay off the loan before the term ends?
✓ #1: If you can afford it, paying off debt can free up cash in the future.
As expenses are recorded in your monthly budget, you have less money to redistribute, save, or spend each month. For example, if you would like to have more expendable cash during the holidays without having to worry about an additional payment, consider making larger payments to knock the debt out early.
✓ #2: Positively affect credit score and usage.
Each open credit item in your portfolio influences your credit score. Making larger payments or paying off your loan early can have a positive impact on your credit score by lowering your current credit usage percentage. This type of loan may also increase the types of credit you have in your portfolio, which helps contribute to a good credit score.
✓ #3: The feeling of being debt-free.
Financial freedom is the ultimate goal for many individuals and families. Knowing that there is one less monthly bill and monetary obligation hanging over your head can release a lot of mental and emotional energy.
If you can comfortably afford paying off the loan, the psychological benefits of being debt-free can outweigh some of the more tangible benefits.
✘ #1: Pay at your own pace and take advantage of the full term.
As long as you are paying the minimum payment required to pay off the loan before any deferred interest sets in, there is no need to potentially put yourself at risk financially by making unnecessarily large payments.
If large payments will put a strain on your wallet or the thought of having less time or cash stresses you out, stick to the term and enjoy the peace of mind of no interest.
Additionally, beware of 0% interest loans that do not allow for early repayment, such as those with prepayment penalties. Prepayment penalties typically exist to prevent borrowers from paying off their loan early to allow interest to build up, which may sound like the opposite of a 0% interest loan. Be sure to read the repayment terms carefully for these types of conditions.
✘ #2: In case of emergency or cash needed elsewhere.
Spacing out payments allows you to budget for an emergency fund. In the event that you’ve paid off your 0% loan and run into an unexpected expense shortly after that you can’t afford, you may have to take out a new personal loan (that likely will not have the 0% interest rate you just finished paying off)!
✘ #3: Pay off other debts or grow money in a savings account.
Take a look at your current budgeting sheet and determine which other debts and bills you have on your monthly tab. If there is another debt with a higher interest rate or balance, it’s a good idea to prioritize those accounts whose balances will continue to grow.
Paying off the account with the highest interest rate first or any revolving credit card debt should always take priority over paying down extra on a loan that is not accumulating interest.
If you have extra cash in your budget that you want to put towards something constructive, consider a savings or investment account.
Depending on your own situation and the potential risks you’re willing to take, eliminating debts early can provide greater a greater sense of financial freedom. If you feel that other areas of your financial life are lacking, such as an emergency
fund or potential investments, consider building those up before making large payments that may inhibit growth for those accounts.
Remember, you don’t have to commit fully to one strategy for paying off this debt. You have the power to adjust your monthly payments according to your lifestyle or financial needs over the course of the term. If you want to pay the minimum required one month and double that the next, you can do that!
Just remember “0% interest” doesn’t mean “no interest ever,” but rather “no interest if the balance is paid within this timeframe.” Deferred interest rates are often high and can be quite the shock. Remain diligent and keep track of the time remaining in your promotional period to make the most of such a useful offer.