Paying off one of your larger debts, or one of your partner's, will probably be one of the first things that crosses your mind if you're fortunate enough to come into a decent amount of cash. Before settling up with a creditor, take some time to work out how much you'd save. You could be better off sticking your money in a savings account or taking advantage of an investment opportunity.
The amount you'd save by wiping out your debt early depends on the size of your outstanding balance, the rate of interest you're being charged, and the term left to run on your credit agreement. You can contact your lender to ask for the total amount it's charging you for the credit you took out, or you can use online interest calculators (see Resources section).
If you're being charged 18 percent annual interest on your credit card, paying off a $5,000 balance today would save you an impressive $13,396.73 in interest compared with making a minimum payment of 2 percent of your balance every month. Clearing that debt by simply paying the minimum installments would take you 472 months -- nearly 40 years.
If you're a little more slack that you could be when it comes to making your loan or credit card repayments every month, you'll also save money by avoiding late payment charges if you clear off what you owe. If you're prone to maxing out a store or credit card, you'll save cash by not being hit with over-limit fees. All these charges accumulate interest once they've been added to your account, so you'll also save on these fees if you pay off the debt early.
Before paying off your debt, find out whether you'd be hit with an early-settlement fee. These can range from a couple of months' interest to a set fee or a percentage of what you've got left to pay. If you're coming to the end of your loan, it might be cheaper for you to leave things as they are and pay the last few installments. If you've got some way to go until your debt will be cleared, you could be better off paying the settlement fee and saving on future interest payments.
Think twice before clearing any debt you're paying a low interest rate on. If you have a student loan or a credit card that's costing you next to nothing in interest payments, consider sticking any lump sum you've been lucky enough to come by into a savings account that pays more interest than your debt costs you. Bear in mind that you'll have to pay tax on any savings income.
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