Should You Pay Off Your Loan?
With investment returns, at best, low and interest rates on homes, 2nd mortgages and even some credit cards at historical lows, should you just go ahead and pay off one or more of your outstanding loans and be done with it?
Unlike most news media and financial pundits, we developed a loan analysis tool which allows you to run two scenarios side-by-side and view the results in an easy-to-read graphical format.
Then we went to town and analyzed a variety of different scenarios. The answer to our question: Maybe.
Key Factors:
1) A lot depends on how much extra money you have each month that you could dedicate to paying off your loan (Note: In financial terms, this is called “available cash flow”).
2) If you invested your money, what would be the after-tax return on your investment?
Example 1: Should I Lock in My Variable Rate?
Let’s say you have a $50,000 loan for your mortgage or second mortgage. Fixed interest rates are presently in the 4% to 5% range. Say you presently have a variable rate that is 5% per year.
What happens if interest rates go up to a historical normal level of 10% per year? Should I lock in my current rate?
First, time is on your side because it’s highly unlikely in our present recession that interest rates will rise significantly.
But say they did jump from 5% to 10%. If you keep paying a $500 monthly payment (total includes interest and principal), it will take you an additional 86 months (a little over 7 years) to pay of your loan at the 10% rate. To counteract the rate increase in terms of additional months to pay of your loan, you’d need to increase your monthly payment to $630.
If you don’t want to gamble, now would be a good time to lock in your variable rate by converting it to a fixed rate with a fixed term.
Example 2: Should You Pay Off Your Loan?
Say you have the same $50,000 loan as in Example 1. But this time, your fixed interest rate is higher, at 7.5%, and you’re unable to refinance the loan. Presently you’re paying $400 per month and will have the loan paid off in 244 months (a little over 20 years).
What should you do?
If you can afford to pay $100 more per month ($23.08 per week) for a total monthly payment of $500 per month, you can reduce the time it takes to pay off your loan by 86 months (a little over 7 years).
That’s a significant savings and better than many present investment options.
How do you accomplish this?
Take a look at our 3 articles on reducing your spending on Entertainment, Insurance, and Groceries. We’re confident that you can “find” $23.08 per week in savings that you can then put toward paying off your loan much faster.
Do It Yourself with our Simple Loan Analysis Software:
Want to compare your loan situation and see how different interest rates and monthly payments affect the time it takes to pay off your loan? Folks who have signed up for our Free E-mail Newsletter have access our free loan calculator.
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